What is RSI?
Is the relative strength index (English is the Relative Strength Index, abbreviated as RSI) is an indicator of the group of momentum indicators in the market. technical analysis developed by J. Welles Wilder was published in the book New Concepts in Technical Trading Systems in 1978 and in Modern Trader (now Futures) in the June 1978 issue.
RSI is an indicator that measures the magnitude and speed (velocity) of price movements to gauge how overbought or oversold the market is. RSI is displayed in the form of an oscillating graph with a value from 0 to 100.
How RSI works
How to calculate RSI
The formula for calculating RSI is as follows:
RSI = 100 – 100 / (1 + RS)
RS = (price increase)/Σ(price decrease) – Average price increase divided by average price decrease.
This calculation is automatically calculated when using charting software such as TradingView or MT4, investors only need to choose to add the RSI indicator.
How RSI works
As mentioned, the RSI is a momentum indicator, which is a type of tool that measures the speed of price movements. The bullish momentum shows that they are being actively bought in the market. The falling momentum is a sign that traders’ interest in the asset classes is slowing down. RSI also detects overbought or oversold conditions in the market.
The structure of the RSI consists of 2 parts: the RSI line calculated as mentioned above and will move up and down in the range from 0 to 100, and 2 upper and lower borders (default is at 30 and 70).
When the RSI is below 30, it indicates that the market is oversold (possibly nearing a bottom and rising again); if the RSI is above the 70 level, it indicates that the market is overbought (possibly nearing a top and bearish).
The initial default, RSI will calculate in a time period of 14 cycles (14 days on daily charts, 14 hours on hourly charts, …). Investors can adjust to increase sensitivity (decrease cycle to shorter) or decrease sensitivity (increase cycle to longer). For example 7-day RSI would be more sensitive than 21-day RSI. In addition, short-term trading setups can adjust the overbought to 20 and oversold borders to 80 (instead of 30 and 70) to limit inaccurate noise signals.
RSI is overbought (overbought)
Usually when the RSI is above 70, it signals that the market is overbought, which usually happens during an uptrend, and signals the market is about to correct or reverse.
The RSI usually gives an overbought signal when the RSI is between 70-100, if you want to get stronger overbought signals, you can adjust the overbought border to 80-100, this also helps. Reduces noisy, overbought signals with low reliability.
RSI is oversold (oversold)
RSI below 30 indicates that the market is oversold. This usually happens during a downtrend, and signals the market is about to rally to the upside.
RSI signals oversold when the RSI value is in the range of 0 – 30.
The oversold is stronger the closer the RSI value is to zero and in the big frame. Multi-frame observation helps to reduce oversemi-noise, low-reliability signals.
RSI Divergence (Divergence)
Besides the RSI levels 30 and 70 indicating oversold and overbought conditions in the market, the RSI can also be used to predict direction reversals or identify support and resistance levels by identifying divergences. .
Divergence is the movement in the opposite direction between price and RSI (determined through highs and lows), for example, rising prices create new highs higher than old ones, but RSI decreases to create new highs lower than old ones, or falling prices create lows. The new low is lower than the old low, but the RSI rises to create a new low higher than the old one. These are the two most basic divergence signals, there are some other more advanced divergences that I will talk about in detail in the section on how to trade with RSI below.
How to trade with RSI
Identify a future trend
The RSI line can forecast a new trend in the following way:
- Uptrend: When the RSI line crosses the 50 level from the bottom up or when the RSI line is in the 40-60 range and suddenly crosses this area to above the 60 zone.
- Downtrend: When the RSI line crosses the threshold of 50 from above or the RSI is in the range of 40-60 and suddenly the RSI falls below the threshold of 40.
Although this signal cannot determine the entry-exit point, when identifying the main trend, it can be combined with the following indicators: Trendline, MA, MACD to conduct trading.
Trade when there is an overbought – oversold signal
Investors can observe an example of using oversold signals such as the following strategy:
Execution strategy on BCH/USDT pair:
It is a new strategy that only applies oversold signals, but the effect is quite high. Should be combined with other indicators to filter noise signals will certainly be more effective.
Execution strategy on BCH/USDT pair:
=> Investors can observe, when using a trading strategy with the RSI indicator, your win rate is up to nearly 59% and brings 50% profit after 68 trades.
It is a new strategy that only applies oversold signals, but the effect is quite high. If you combine it with other indicators to filter out the noise signal, the effect will definitely be more optimal
Using RSI as a divergence signal
Using RSI and some other indicators (Momentum, MA, MACD…) you can identify Divergence at which price will tend to reverse.
- Peak divergence.
- Bottom divergence.
- Closed divergence.
Peak divergence: Where the price is higher than the old high but the RSI is lower than the old high. Now we can find the Short entry.
When the RSI hits the trendline again, we can enter a short position, as you can see in the example in the picture, when the RSI touches the trendline again at $12,000, the price has dropped from $12,000 to below $10,000.
Bottom divergence: There price is lower than the old low but the RSI is higher than the old bottom RSI: Find a Long entry there.
Closed Divergence: Price trendline is NOT in the same direction as RSI trendline (Excluding Normal Divergence):
- Price goes up but RSI is flat.
- Price goes down but RSI is flat.
- Price is flat but RSI is down.
- Price is flat but RSI is up.
Although RSI is a pretty sensitive indicator, you should still combine RSI with other indicators: MACD, Bollinger Band, MA, Resistance – support, Volume.
Mistakes when using RSI
Many traders use extremely mechanical indicators, you need to understand that: every indicator has its own meaning, but if you don’t understand it well, you will make mistakes while trading. With RSI, the biggest mistake is usually to enter an order as soon as there is an overbought/oversold signal.
Enter orders as soon as there is an overbought signal: normally, RSI touching 70 is considered overbought, but in fact, the overbought zone is between 70-100. Thus, if the price still goes beyond the 70 zone and reaches the 75-80 zone, your SELL order may have been liquidated.
Similar to the oversold zone, when the RSI drops below 30, it is unlikely that your buy order will be liquidated because the price may continue to fall further to 20-0.
Videos How to use RSI in trading
Trading signals according to the RSI indicator is extremely effective if investors understand and know how to combine with other indicators. As the simple strategy I have implemented as above, you also find the effect is quite good. Build a strategy for yourself and test which strategies work best and apply them to your trading process.
Investing is a long-term process that takes experience. If this article brings useful knowledge, please share it with everyone.