What is RSI and how to use it in technical analysis?

According to some traders, technical analysis is one of the powerful and effective methods for predicting the market and profiting from price fluctuations of digital assets. Among the various tools that technical traders often use for market analysis, Relative Strength Index which in short RSI is called, it is one of the popular indicators.

In this article we are going to check What is RSI? And learn more about how to calculate and function and how to read it in price charts. Also, we explain what elements this indicator consists of and how it can be used in market analysis and trading; So follow us to the end of this article.

What is the RSI indicator?

RSI Or Relative strength index One Momentum indicator is that market trend And The speed of price changes examines RSI is a linear chart between two Upper and lower band It fluctuates. RSI above 70 is overbought And Exit signal And RSI below 30 oversold and signal log in Is.

The RSI indicator is considered an oscillator. Oscillators, by moving between high and low limits, can evaluate asset fluctuations and price momentum and the level of market excitement, and show the results of this analysis to traders in the form of numbers or graphs at the bottom of technical analysis charts.

Using oscillators in range markets and without trends for people who trade in shorter time frames can bring the best results.

Read more: How to trade in Range-Bound market?

So we understood that the RSI indicator can help the trader to determine the entry and exit points of the trade. Although this indicator can be misleading at times, traders who understand how it works can have a more accurate view of price movements and better predict the short-term future of the market.

Read more: How to determine the target in trading?

It is not bad to know that the first time J. Welles Wilder Jr. (J. Welles Wilder Jr.), who some consider to be the father of technical analysis indicators in the trading market, introduced the relative strength index in 1978 in the book “New Concepts in Technical Trading Systems”. did

RSI indicator calculation formula

By default, the relative strength index examines the average upward price changes (average profit) with the average downward price changes (average loss) in a 14-period period. For example, if you apply the RSI indicator on a one-day chart, the last 14 days are considered, and if you apply it on an hourly chart, the last 14 hours are considered in the calculations. It should be noted that it is possible to change the time frame according to your trading strategy, and this indicator works in any time frame.

The formula for calculating the RSI indicator is as follows:

In the above formula, the average of Sudosian is calculated based on the number of candles that were closed with profit or with loss compared to the previous candle. In general, the average of the candles that closed with a closing price higher than the closing price of the previous candle is considered the average profit. Accordingly, the average of candles that close at a lower closing price than the previous candle is calculated as the average loss.

However, in general you don't need to worry about calculating the relative power index formula; Because all trading platforms provide calculated relative strength index values, and with a few simple clicks, you can see the relative strength index chart in the trading charts.

How to read the RSI indicator?

In RSI indicator charts, you often see three lines: two straight dotted lines above and below and a curve in the middle that sometimes crosses the two upper and lower dotted lines; But it usually fluctuates between these two lines.

This curve is the RSI indicator and it indicates that the trading asset is in the overbought or oversold range. When the RSI indicator reaches the value of 30 or less, the asset is in the oversold range, and when it crosses the value of 70, the asset enters the overbought range.

Just because an asset is oversold or overbought doesn't mean the market will change; Rather, it means that everything is moving faster than it should.

The relative strength index can help determine market conditions and identify price trends. If the relative strength index fluctuates within the 50 line, the market is in a trend condition. If we see the RSI crossing above 50, we are dealing with a positive trend and a bullish market, and prices are rising. The drop of the indicator below 50 also indicates a decrease in prices and the formation of a bearish market.

However, despite all the information we get from the relative strength index, it is still better not to rely solely on one indicator and always use several different indicators to ensure the accuracy and validity of buy and sell signals.

What is RSI Divergence?

RSI divergence It happens when Price A digital asset reach a new ceiling or floor; But the RSI indicator shows values ​​corresponding to it don't give. in this case, The price trend and the indicator curve move in opposite directions. This divergence can have two modes ascending And Descending have

• Downward divergence: It happens when the RSI indicator, unlike the price chart, does not form a new ceiling, and this indicates the weakening of momentum.

• Ascending Divergence: It happens when the price of the asset reaches a new low; But the RSI indicator does not confirm it and cannot make a lower bottom. Traders interpret this as a buy signal.

In general, a divergence between the asset price chart and the RSI indicator can indicate a trend reversal.

Price convergence and divergence

The most important trading signals of RSI indicator are “convergence” and “divergence”. Traders use these signals to recognize price and predict when the market is about to change trends. The phenomenon of convergence occurs when the price and the technical indicator move together.

To determine the convergence structure, the price chart should be aligned with the moving average or relative strength indicator. The phenomenon of divergence is exactly the opposite and occurs when the price chart and the RSI indicator move in the opposite direction.

The RSI divergence pattern is usually seen a few candles before the uptrend reverses or support breaks and can confirm the possibility of an uptrend reversal. If the value of the asset rises and at the same time the RSI oscillator falls, the trader can detect a bearish divergence. In the opposite situation, that is, when the value of the asset decreases and the oscillator continues to move upwards, we see a bullish divergence.

Another condition may also occur, which is called failure swing. Incomplete Oscillations are trend reversal signals and occur when the oscillator chart does not follow the pattern of peaks in an uptrend or valleys in a downtrend. In this situation, we will probably see the following two situations:

• Incomplete peak oscillation: This state occurs in an upward trend and when the price reaches a new peak; But the RSI indicator crosses the last bottom that led to the highest peak; That is, it breaks its upward trend. In this case, with the signal sale We are facing each other.
• Incomplete Valley Oscillation: In this situation, the price reaches a new valley in a downward trend; But the RSI indicator crosses its last peak, which formed the lowest valley, and breaks its downtrend. This condition can be a signal for Buy Be considered.

The difference between the RSI indicator and the MACD indicator

Moving Average Convergence Divergence or MACD is another popular momentum indicator that measures the acceleration of asset price movement.

Read more: Complete training on using the Macdi indicator in trading

The MACD indicator measures the divergence of two exponential moving averages (EMA). These moving averages are usually 12 and 26 periods. The MACD curve is the result of the difference between these two moving averages. A 9-period moving average called a signal line is also shown on the MACD curve. Many traders use this indicator to identify short-term buy and sell signals.

When the MACD crosses the 9-period moving average signal line upwards, we are facing a buy signal, and the MACD line crossing the signal line downwards indicates a potential sell position.

The RSI indicator gives traders a general idea of ​​recent price changes; While we can consider the MACD as a measure of the correlation between two moving averages. Many traders use these two indicators to predict future price movements and identify trading signals.

Although RSI and MACD are both momentum indicators, they each measure different variables and may generate conflicting signals. For example, if the RSI shows a value above 70 for a long period of time, it can indicate overbought conditions and convince the trader that a price correction is on the way. Meanwhile, the MACD indicator may indicate that prices are reaching their highest ceiling.

In other words, these two indicators are complementary and are often used together. While the MACD uses exponential moving averages, the RSI indicator shows a chart of recent price lows and highs. It is much easier to identify the range market using the MACD indicator, and the RSI indicator can show the reversal of the trend by showing oversold and overbought areas.

Read more: How to use simple and exponential moving averages for trading?

How to use the RSI indicator in your trading?

First, activate the RSI indicator in your trading platform. The default period of this indicator is always considered to be 14, so we suggest you continue your work with the same settings.

Signals presented on higher timeframes will be stronger than signals presented on lower timeframes. It is important to note this point; Because by starting to use the relative strength index indicator, you will realize that you may detect a bearish divergence in the 15-minute timeframe; But this divergence is not shown in the one-hour time frame or, for example, the bearish divergence in the daily time frame is significantly more significant than the bearish divergence in the 5-minute time frame.

Next, we mention two strategies for using the RSI indicator in market analysis:

• Signals of overbought and oversold areas in the range market: Although one of the most widely used RSI strategies is to identify overbought and oversold areas in a market range, there is no guarantee that you will be able to accurately identify the last floor or ceiling. Also, buying solely based on the oversold signal is very risky; Because as we explained, even when you are facing an oversold signal, the market may still continue its downward trend. Using RSI alone is not enough; Therefore, we do not recommend that you build your entire trading strategy solely on the basis of this indicator. Nevertheless, the relative strength index helps you make better decisions and gain a broader view of the market. Overall, we suggest using different types of moving averages and Bollinger Bands along with RSI to confirm signals and make more informed trading decisions.

• Trading based on upward or downward divergence and convergence: The second strategy is based on divergence and can be more interesting. For example, if you want to be sure of the formation of a valley or a peak on the chart, you can look for divergence on the RSI indicator. If you see a bearish divergence in the RSI indicator along with the formation of a double pattern, you should consider selling the asset, and if you encounter a double pattern and an upward divergence, you can potentially place a buy order. In this case, your loss limit should be set lower than the previous floor; Because according to your analysis, no new floor will be created. If the price goes lower and makes a new low, then your analysis was wrong and your stop loss is activated.

Don't forget that stop loss activation is not a big problem and risk management will be an important part of your trading. In fact, by creating a loss limit you allow yourself and your strategy to make mistakes every now and then.

Read more: How is risk management in the digital currency market?

The market is unpredictable; Therefore, you must allow yourself to accept any outcome in order to still win the field in the long run. For this reason, it is better to set the loss limit to only 1-2% of your trading portfolio. Ideally, it is better to test your strategy on paper several times without entering money into the market and after making sure that it is profitable, enter your capital into the market.

Important points in using the RSI indicator

Like all technical indicators, relative strength indicator signals are associated with a percentage of error. The important thing is to be aware of the past and present performance of the indicator while using it. Next, we mention three important points that you should be aware of when working with the RSI indicator:

• False signals: Unfortunately, the RSI indicator sometimes creates a false signal. When the RSI reading is higher than 70 or lower than 30, we are facing a false or fake relative strength indicator signal. This phenomenon is usually seen in digital currencies that are in the middle of a strong trend. As a result, false buy or sell signals are created; Because we do not see strong movements in the upward or downward direction of the market. In order to solve this problem, it is better to use RSI with other technical or fundamental indicators. For example, many traders combine RSI with Bollinger Bands or moving averages or Fibonacci retracements to improve the performance of the indicator. Regardless of the cryptocurrency you trade, it's a good idea to use at least one other indicator alongside your RSI-based strategy.
• Process return: As we mentioned, the relative strength indicator is generally designed to identify market trend reversals. The market reverts when the price movements are weak and ready to reverse. One of the benefits of a market reversal is the possibility of receiving large profits, which is not uncommon in the digital currency market. Although the RSI indicator often works standardly with parameters of 70 and 30, some traders consider parameters of 80 and 20 for overbought and oversold zones, respectively. In addition, using different time frames, including hourly, daily and weekly charts, can help increase the accuracy of your analysis. With this action, the relative strength index can be used to identify overbought or oversold conditions at both macro and micro levels.
• risk management: Regardless of the trading strategy, it seems necessary to consider parameters for risk management in order to succeed in trading. Also, due to the fluctuations of the digital currency market, risk management becomes very important. Do not forget that the relative strength index is only a technical indicator and cannot be complete by itself. The only way to ensure that an RSI-based strategy is working effectively is to use it consistently over the long term. By constantly testing your strategy, you ensure that your winnings are the result of your own efforts and not luck. For example, a solid risk management strategy says you should never risk more than 3% of your account balance on a cryptocurrency trade. This approach, known as the “3% Rule”, will keep your trading account healthy and profitable at the same time.

Common mistakes in using the RSI indicator

No strategy is foolproof; Therefore, try to avoid the following problems when using the relative strength index:

• Ignoring fundamental parameters: Regardless of the digital currency you trade, it is always better to be aware of the news and fundamental data of the asset you are considering. Surprising news or government regulations or cyber-attacks can render any strategy ineffective, including an RSI-based strategy.
• Improper capital management: If you plan to succeed in your trading, be faithful to the principles of capital and risk management. Also, don't invest all your capital in one trade and take a long-term view.
• Trading based on emotion: Try to trade in a measured, stable and regular way; Otherwise, you may suffer in emotional trading with irrational and excessive leverage.

Frequently asked questions

TotalTheclassification

In this article, we introduced the relative strength index (RSI) momentum indicator and explained how this oscillator can identify oversold and overbought points by examining market trends. Also, we talked about the method of reading the RSI index and the different interpretations it provides in different market conditions, as well as its performance in the analysis.

Next, we highlighted some of the differences between two popular oscillators, RSI and MACD, and told how using these two oscillators together can help in better market analysis. Also, we reviewed the concept of divergence in the relative strength index and in the end, we pointed out important points and common mistakes that traders may make when working with the RSI indicator.

The relative strength index measures the acceleration of changes or market trends; Therefore, checking the changes of this indicator along with checking the price changes can be a tool for traders in correctly identifying the time of the trend reversal and determining the best points to enter and exit the market. However, the RSI indicator, like many other technical analysis indicators, is associated with a high percentage of error and sometimes gives a wrong signal. The best trading strategies often examine a set of indicators together and do not neglect to pay attention to news and fundamentals.

Do not forget that neither the relative strength index nor any other indicator alone can provide you with a complete view of the market.