Technical Analysis

Relative Strength Index ( RSI ) | Beginner’s Guide

Relative Strength Index (RSI) is one of the most used and most famous trading indicators out there. It’s a momentum indicator used by traders to know whether an asset is oversold ( below 30% ) and may bounce back upwards or whether it is overbought ( above 70% ) and may do a bearish reversal. 

Seems quite simple, Yes ?

Answer is NO. 

RSI is mostly used in combination with other indicators as using just this one won’t get you anywhere. 

Particularly, If you’re trading in the Crypto market then a simple overbought and oversold would be of no good in intense bull runs and bear runs. For example, just look at the chart below. 

Failed RSI overbought theory.

If someone would have gone by this overbought and oversold strategy, then he exited at point A and point C. It would be an understatement to say that he missed some profits. But if 70% and 30% levels are not helping then what levels to watch ?

A well-known market technician Constance Brown, CMT, has promoted the idea that an oversold reading on the RSI in an uptrend is likely much higher than 30% and that an overbought reading on the RSI during a downtrend is much lower than the 70% level. 

Most often traders mark 50% as an oversold region during strong uptrends and the same 50% region would act as overbought during a strong downtrend. 

This 50% mark worked brilliantly on the BTC/USD chart above. 

Divergence

RSI Bullish and Bearish Divergence gives you some great entry and exit points. Not 100% but most of the time when an asset rises or falls sharply, a divergence is formed at the end of that trend signaling a potential reversal.

RSI Bearish Divergence examples

Bearish Divergence: If the price of an asset creates a higher high but RSI creates a lower high, this means that bulls are losing strength and we might see a bearish reversal here.

Look at the chart above and you’ll see two examples of bearish divergence coming into play. One is marked in black and the other one in orange.

RSI Bullish Divergence example

Bullish Divergence: If the price of an asset made lower low but RSI made a higher low, this means bears are losing strength and we might see a bullish reversal.

Look at the chart above, price made a higher low from point A to point B while RSI made a lower low at the same time, giving price a bounce of 25%.

Apart from above mentioned two scenarios, we’ve two more bullish divergence patterns and two more bearish divergence patterns. Find these in the cheat sheet below. 

Image by Marvin Chebbi, CryptoTrendy 2018

Conclusion: 

While RSI is a great indicator to know the momentum and find potential entries near the top and bottom of a trend, It should not be used alone. Always use it in combination with at least one more indicator or price action. 

I hope you found what you were looking for in this post, If you’ve any other query, you can let me know in the comment section below.

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