Crypto Investing
1 Dec 2021

What is RSI? – Relative Strength Index Indicator Explained

Ananda Banerjee

Hello, happy investor. As much as we would want you to keep focusing on fundamental analysis, for now, learning a bit about the most credible forms of technical analysis will do no harm. But then, is it just about the price bars, moving averages, and candlestick patterns when it comes to chart analysis? And, why are we even looking at the more immediate price-time indicators if going long with an asset class is a priority?

Well, the explanations are pretty simple. First of all, investing or rather going long doesn’t mean that selling or even adding more is prohibited. Rather, a good investor is the one who books profits at peaks and adds more to the portfolio when the asset class gives out buy signals. 

But, you still have to identify those signals. This is where technical analysis of crypto becomes all the more important—now coming to the other question as to which technical resource is the best for long-term traders. While choices galore, hardly any works better than an RSI indicator when it comes to tracking trend reversals, exit points, ideas for new positions, and the exploitable trading regions.

What is an RSI Indicator?

Asset (cryptocurrencies in our case) class monitoring, regardless of the type of investment opportunity in play, is plagued by the problem of the plenty. There are many indicators of relevance, but the relative strength index indicator is the one that actually gives out the best buying or selling signals. 

Touted as a momentum indicator, RSI determines whether the cryptocurrency, stock, or any other asset class is in the overbought or oversold region. Plus, the RSI full form, i.e., Relative Strength Index, reveals that the calculations and inferences are based on the relative closing prices of the particular asset class over a given time frame.

Relative Strength Index Facts

Confused much! Well, here is a simpler explanation for better understanding.

Imagine that a particular cryptocurrency is trading at Rs. 10,000 on a given day. Plus, it has been peaking for the past three days, thereby leaving you perplexed about the entry point if you are contemplating entry or the right selling level if you want to take out some ready profits.

In some cases moving averages and crossovers indicate the right entry or exit points, but they aren’t always reliable, especially when the market sentiments are hinged in a particular direction, or you encounter whiplashes, i.e., steadily oscillating price bars on either side of the moving average line.

At this point, RSI comes to the rescue by helping the investor gauge the stock’s true value and how it has been fairing in a bullish or a bearish market. We would still not delve into the nitty-gritty of the same, at least not yet, but it is safe to know that the RSI figure for a given asset ranges between 0 and 100.

RSI Meaning: Here is how to get ahead of the Mathematics around this Index?

Asset prices change every instant while the market is open. Therefore, the only way to take an entry or exit call is to know the relative strength of the same over a certain timeframe, which reveals whether the asset has been bought excessively and is awaiting an evident fall or if the asset is trading way lower than its actual price and is a good time to buy.

Also, at the end of the day, RSI, like any other technical indicator, is subject to mathematical postulates and calculations, with the generic formula listed as:

RSI = 100 – [100/ (1+RS)]

At this point, RS signifies the average gain or the average loss, depending on the trend the asset is riding.

Also, when it comes to calculating the average gain or loss, a 14-day timeframe is usually preferred. But then, if you are buying and selling assets over a dedicated investment platform, you need not get into the nitty-gritties of calculations as the interface does the same for you and helps you place the lines on the asset chart to perfection.

However, RSI works better when used alongside a stochastic oscillator. This approach makes it easier to gauge the market sensitivity and take investment calls accordingly. 

Easy, right! As much as this seems like a straightforward process, some perspective and practice are necessary to use RSI as a trading and even an investing tool.

How to Use RSI as an Investing Tool?

Believe us when we say that interpreting RSI to perfection is often the trick to making prudent investment-specific decisions. Also, based on your familiarity with the concept, RSI can be viewed simply as a standalone entity or a part of the RSI divergence format, which then sends out more accurate signals.

Standard RSI Indicator

Overbought Asset

If, for a given asset, the standalone RSI figure goes above 70 or even 80 in some cases, the zone is termed as overbought. At this level, chances of price pullback are notoriously high. Therefore, if you are sitting on decent profits, the overbought region can be a good exit point.

Oversold Asset

Provided the asset price has been dropping for a while now, it is advisable to keep an eye on the plummeting RSI value, with a drop beyond 30 indicative of its oversold nature. Statistically speaking, an oversold region can be a good entry point, especially if you are planning to enter, more as an investor than a trader.

RSI Divergence: Better Indicator to Consider

Exit Point

Standalone RSI indications can be outpaced by real-time market sentiments, especially when volatility is high. RSI divergence, i.e., RSI paired with an oscillator, monitors price movements more accurately and helps you choose entry and exit positions to precision. 

For this approach to work, you would need to monitor the asset prices and the RSI simultaneously. If the asset keeps making higher highs, but the RSI disagrees with lower highs, you get a bearish divergence and a reason enough to consider exiting with profits.

Entry Point

In case the asset signifies lower lows in terms of price action, but the RSI indicator doesn’t drop as much and makes higher lows, you might be looking at an upcoming upward trend or rather a good enough, investment-specific entry point. 

RSI as Trend Validators

The likes of Bitcoins, Ethers, and more often follow trends. Be it an uptrend or a downtrend; you can always use the RSI indicator to validate it before entering, simply to rid the concerned drift. 

Uptrend Validator

If the time-bound RSI stays above 30 during an up move and often peaks at 70, the crypto asset is safe to be considered riding an uptrend. Even if there is a downtrend, the inability to hit 30 and consistently staying close or above 70 hints at a trend reversal and a possible upward retraction.

Downtrend Validator

If the RSI fails to sustain 70 and keeps falling below 30, you might be looking at a strong downtrend. Also, even if during an uptrend the asset is finding it hard to touch 70 whilst occasionally dropping a fair bit, lower retracement and trend reversal might be evident. 

While this is more of an RSI explainer for a beginner, experienced investors often pair it with the likes of lagging indicators like Bollinger bands and other momentum indicators like MACD to further strengthen their assertions.

FAQs on RSI Indicator

Q1. What is a good RSI number?

A1. More than the number, it is the permanency of the same that matters. For instance, an RSI number between 40 and 50 is good for buying, provided it isn’t diverging from the usual pattern of higher highs made by the asset on the price-to-time chart. 

Q2. What is an RSI Buy signal?

A2. If the asset RSI is under 30 and keeps making higher lows than the lower lows on the price-time chart, you can consider this a buying indication. 

 Q3. What does RSI 14 mean?

A3. RSI chart calculated over a period of 14 days is termed RSI 14. However, it isn’t a set norm as short-term traders also opt for a calculation period of 9-11 days, whereas long-term investors prefer something in the 20 to 30-day range. 

Q4. How do you use an RSI indicator?

A4. RSI tracks the magnitude and nature of price changes as a momentum indicator, thereby letting you into the oversold or overbought regions. These ideas help you make better buy and sell decisions, respectively.

Ready to put the RSI knowledge to good use! Download the app and start trading, right away.

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

writer

Ananda Banerjee

Content Writer

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