Bitcoin trading may be intimidating as it appears to be an intricate underworld of charts, graphs and foreign terminology. However, hidden within this complexity are potent tools that can assist traders in making smarter decisions. One of those tools would be the Relative Strength Index, or RSI. In this guest post from OverTraders.com, read a thorough yet layman friendly breakdown of the RSI. Let’s go through what RSI is, how it works, and how you can use the RSI to improve your Bitcoin trading strategies.
Understanding the RSI Indicator
The RSI is one of the most popular momentum indicators used in technical analysis. This is hugely valuable for traders because it provides them insight into the severity behind recent price movements. With this data, they’re able to determine if a specific stock or asset is overbought or oversold. Knowing what is behind the RSI gives traders the power to spot likely trend reversals before they happen. With this information, they are better equipped to make smart long trades.
Definition of the RSI Indicator
The RSI, developed by J. Welles Wilder Jr., is a momentum oscillator that measures the speed and change of price movements. It jumps back and forth between 0 and 100. Historically, the RSI is thought of as overbought once it’s above 70 and oversold once it’s below 30. These thresholds are flexible and so can be calibrated to more appropriately match the nature of a given asset type or market. The RSI can do more than just tell us when to buy or sell. This will assist you in gauging how strong a trend is and how likely a trend is to reverse.
RSI Indicator Formula
The formula to calculate the RSI is:
RSI = 100 – [100 / (1 + RS)]
Where:
RS = Average Gain / Average Loss
Average gain and average loss are simply the average of all gains and losses over a given period (e.g. 14 days). These values are then smoothed based on a selectable smoothing factor to offer a more stable overall reading.
Interpreting the RSI
Interpreting the RSI involves understanding what the numbers and patterns suggest about the current market momentum. Looking to explore potential trend reversals earlier in an uptrend or downtrend by capitalizing on short-term overbought or oversold conditions? Moreover, bullish and bearish divergences between the RSI and price action can be powerful signals of imminent directional moves in an asset’s price.
Identifying Overbought and Oversold Conditions
The RSI is widely used oscillator that can alert traders to potential reversals based on overbought or oversold readings. Typically, an RSI reading above 70 suggests that an asset is overbought. On the other hand, a reading of less than 30 means that it is oversold.
Overbought: When the RSI is above 70, it indicates that the price has risen excessively and may be due for a pullback. Speculators may want to book profits or position for a possible short trade.
Oversold: When the RSI is below 30, it suggests that the price has fallen too much and may be due for a bounce. Traders may seek to establish new buying positions or close their short positions.
Recognizing Buy and Sell Signals
These overbought and oversold levels can alert you to possible buy and sell signals. It is always best to validate these signals with other corroborating indicators and analysis methods. Thus, waiting for the RSI to cross back below 70 before selling can prove a powerful strategy. This indicates that the market has transitioned from overbought to a more accurate sell. Conversely, waiting for the RSI to cross back above 30 once the asset has been oversold is often a better buy signal.
The second technique is to identify bullish and bearish divergences. A bullish divergence occurs when the price forms lower lows, but the RSI forms higher lows. This bullish market pattern shows that selling pressure is weakening, signaling a potential bottom and subsequent upward reversal. A bearish divergence occurs when the price makes higher highs, while the RSI makes lower highs. That indicates buying pressure is running out, potentially setting up a downward reversal.
Utilizing RSI Across Timeframes
You can use the RSI across various timeframes. It’s an excellent indicator when working on short-term charts, in 5-minute or 15-minute intervals, but on a longer-term daily or weekly chart. The time period selected will vary based on the trader’s approach and goals. Day traders might be looking at 1-minute timeframes, while your long-term investor would be looking at daily or weekly timeframes.
Short-Term vs Long-Term Strategies
Short-Term Strategies: On shorter timeframes, the RSI can generate more frequent signals, making it suitable for day trading and scalping strategies. The downside of these signals is that they are noisier and more prone to false positives. For traders using short-term strategies, additional filters will be needed. These tools can make a big improvement to the precision of their signals.
On longer timeframes, the RSI provides fewer signals, but these signals tend to be more reliable and can be used for swing trading or longer-term investing. Long-term traders widely use the RSI to identify significant trend reversals. They further use it as a guide to locate possible entry and exit points for their positions.
Best Practices for Different Trading Styles
Day Traders: Day traders often use shorter RSI periods, such as 9 or 10, to capture quick momentum shifts. They might use the RSI in conjunction with other indicators such as moving averages or MACD to provide confirmation of their signals.
Swing Traders: Swing traders typically use longer RSI periods, such as 14 or 21, to identify potential swing trades. They will further search for divergences and other patterns to determine high-probability trading opportunities.
- Long-Term Investors: Long-term investors often use the RSI on weekly or monthly charts to identify major trend reversals. Additionally, investors can utilize the RSI alongside fundamental analysis to guide more strategic investment choices.
Advanced RSI Techniques
Traders can do more than just identify overbought or oversold levels. Here are some of those more wiz bang techniques that they can use to take their RSI analysis to the next level. Some of these methods are divergence analysis and using the RSI in conjunction with other indicators.
Understanding RSI Divergence
Divergence is a type of divergence that happens when the price action and the RSI are moving in opposite directions. When it occurs, that can be a powerful signal of a LONG-Term trend reversal.
Bullish Divergence: This happens when the price makes lower lows, but the RSI makes higher lows. It indicates that the downward selling force is fading and a trend reversal up to the positive direction is imminent.
Bearish Divergence: This occurs when the price makes higher highs, but the RSI makes lower highs. Secondly, it shows that the buying pressure is weakening and a reversal to the downside is starting to form.
Combining RSI with Other Indicators
To increase the effectiveness of RSI signals, trader will typically use it in conjunction with other technical indicators. Some popular combinations include:
Moving Averages: Using moving averages can help confirm the direction of the trend and filter out false RSI signals. So a potential buy signal created by the RSI receives confirmation when the price crosses above a chosen moving average. This three year moving average should be increasing.
MACD: The MACD (Moving Average Convergence Divergence) is another momentum indicator that can be used to confirm RSI signals. A bullish crossover in the MACD serves to confirm a buy signal from the RSI. In a bearish crossover, the crossover confirms a sell signal.
Fibonacci Levels: Fibonacci retracement levels can be used to identify potential support and resistance levels. Traders using RSI signals alongside these levels will be better positioned to identify high-probability trading opportunities.
Practical Application of RSI
To demonstrate the RSI in action, let’s take a look at a case study example of trading XAUUSD (Gold). Further, we’ll look at the best RSI settings to tailor this indicator for use.
Case Study: Trading XAUUSD
Let’s say a trader is reading the daily chart of XAUUSD. They notice that the price has increased every day for the past few weeks. On the RSI, it shows a bearish divergence. The price is surging to record levels. At the same time, the RSI has printed a series of lower highs, proof that the buying pressure is beginning to relent.
After all this analysis, the trader may decide to take up a short position on XAUUSD. Alternatively, they can allow the RSI to fall below 70. Or, they could wait for the price to break below an important support level before initiating the position. Then, you can set a stop-loss order above that recent high. Second, place a take-profit order just above a possible support line.
Customizing RSI Settings for Optimal Use
The default RSI period is 14 periods. The good news is that traders can simply change this default setting to fit their individual trading style and the unique characteristics of the asset they are trading. Shorter periods, such as 9 or 10, increase the sensitivity of the RSI to changes in price. This increased sensitivity will result in much more frequent positive signals. Longer periods, like 21 or 30, make the RSI less sensitive and offer more reliable signals.
Traders looking for a more tailored approach can modify the overbought/oversold levels to suit the specific asset being traded. If an asset is very volatile, the trader would probably increase the overbought threshold to 80. At the same time, they might reduce the oversold threshold down to 20.
Using the RSI Indicator on Trading Platforms
The RSI indicator implementation on the readily available trading platforms such as TradingView and MT4 is quite simple. Here’s how to download and use the RSI on all three platforms.
How to Implement RSI on TradingView
Log in to your TradingView account or create a new one.
Select a Chart: Choose the asset you want to analyze (e.g., Bitcoin).
Add the RSI Indicator:
Simply click on “Indicators” at the top of the chart.
Just enter “RSI” into the search bar.
- Click on “Relative Strength Index” by TradingView.
- Customize Settings (Optional):
To do so, click on the settings icon right next to the RSI indicator in the chart.
Modify the length (period), overbought, and oversold levels to your preferences.
- Analyze the Chart: The RSI will appear below the price chart, showing the momentum of the asset.
Adding RSI to MT4
Log in to your MetaTrader 4 (MT4) account.
Select a Chart: Choose the asset you want to analyze (e.g., Bitcoin).
Add the RSI Indicator:
- Click on “Insert” on the top menu.
From “Technical Analysis,” then “Indicators,” then “Oscillators,” and finally, “Relative Strength Index.”
- Customize Settings (Optional):
Change the time period, use of , , , , , and line width.
Click “OK” and the indicator will be added to your chart.
- Analyze the Chart: The RSI will appear in a separate window below the price chart, displaying the momentum of the asset.
Common Strategies with the RSI Indicator
The RSI oscillator can be applied in different trading tactics such as day trading and swing trading. Yet each strategy needs the right context and/or application in order to get the best out of it.
Effective Strategies for Day Trading
When applied for the purposes of day trading, the RSI may be used to signal short-term overbought and oversold conditions. Here are some effective strategies:
- Overbought/Oversold Reversals:
- Watch for overbought (above 70) or oversold (below 30) RSI levels.
Wait for the RSI to drop back below 70. This will signal a true reversal.
Open a short position when RSI crosses below the 70 level. Conversely, short when it crosses below 50, and go long when it moves above 30.
- RSI Divergence:
• Determine bullish or bearish divergence on the chart.
3 – Validate the divergence with other indicators or price action patterns.
Make your initial trade in the direction of the predicted price reversal.
Best Settings for Swing Trading
Swing trading is the practice of holding positions for days or weeks to take advantage of price swings on a short- to medium-term timeframe. Here are some RSI settings and strategies suitable for swing trading:
- Longer RSI Periods:
Use an RSI period of 14 or 21 to reduce noise and focus on more significant price movements.
Change overbought and oversold levels to 80 and 20, respectively, to catch more powerful trends.
- Trend Confirmation:
5 Confirm the trend with the RSI Use the RSI to check the direction of the current trend.
Go long when RSI is greater than 50 and price is above the positive trend line.
- Enter long positions when the RSI is above 50 and the price is in an uptrend.
- Swing Rejections:
Find swing rejections where the RSI moves into overbought or oversold waters and then reverses back away from the extreme level.
Go long when the RSI turns upward out of the oversold zone. Conversely, short when it starts to reverse back from the overbought level.
Frequently Asked Questions
Here are the most frequently asked RSI questions to shed some more light on this complicated indicator and how to use it.
What is a 30/70 RSI Strategy?
One of the most common RSI strategies is 30/70 RSI strategy. When the RSI dips below 30, the asset will be seen as being oversold, which may indicate a good time to buy. On the other hand, when the RSI moves above 70, the asset is overbought, which presents a potential selling opportunity.
What is a Good RSI Indicator?
A quality RSI indicator provides consistent, accurate, and timely signals. These signals perfectly match a trader’s strategy and risk tolerance. On the RSI, you frequently have to fiddle with the settings. Period and overbought/oversold levels should be adjusted for the specific asset and current market conditions.
What is a Good RSI Number to Buy?
So an RSI number that is below 30 is generally a pretty strong signal to look at buying. This level shows that the asset is oversold and may be set for a rally. You have to use additional confirming indicators and analysis methods to corroborate the signal.
How to Avoid False Signals with RSI?
To avoid false signals with the RSI, traders should:
Use Longer Timeframes: Longer timeframes tend to produce more reliable signals.
Confirm with Other Indicators: Combine the RSI with other indicators like moving averages or MACD.
Look for Divergences: Identify bullish or bearish divergences to confirm potential reversals.
Adjust Settings: Customize the RSI settings to fit the specific asset and market conditions.
What is the RSI Indicator for XAUUSD?
The RSI indicator on an asset like XAUUSD (Gold) is used no different than for other assets. It is used to see the speed of price changes in high and low period and it oscillates between 0 and 100. Traders can use the RSI to identify possible overbought and oversold conditions. Along with confirming trends and spotting divergences, this oscillator is another way to make informed trades on XAUUSD.
Conclusion
Traders consider the Relative Strength Index to be a one-stop-shop indicator for Bitcoin. It provides harmful market momentum and points out clear building trend reversals. By understanding how to interpret the RSI, utilize it across different timeframes, and combine it with other indicators, traders can enhance their trading strategies and make more informed decisions. Whether you’re a day trader, swing trader, or long-term investor, you can greatly strengthen your trading arsenal. The RSI provides some useful information that will help you improve your trades. Configure your settings in-home to up your trading game. Use the RSI in conjunction with other indicators to validate signals and reduce the chance of false positives.
About the Authors
OverTraders.com is an exciting new online community focused on helping traders and investors achieve their financial dreams. We deliver deep, actionable analysis on global financial markets – equities and crypto – combined with real-time data feeds and learning tools. Whether you’re an experienced trader or new to trading. At OverTraders.com we’re equipping you to conquer the challenges of today’s markets.
