Technical analysis is undoubtedly efficient on the volatile cryptocurrency market. Technical indicators are various and many. They are designed to indicate the entry and exit points, whether an asset is overbought or oversold, and whether the bullish or bearish powers are strong enough to push the price in a certain direction.
“Entry and exit points are vital parts of trading and investing, whether you are day trading, swing trading, or investing long term. Why would you ever buy a stock at the wrong time? Unfortunately, there are many market participants with no training that do it every day.”
Charting and technical analysis expert
To avoid common trading mistakes, you need to educate and train yourself in historical data. This will allow you to see patterns and easily discover new entry and exit points. Today, we’d like to talk about one of the most popular and widely used indicators — the relative strength index, or RSI.
What is the RSI indicator & how to calculate RSI
The meaning of RSI is pretty simple. It’s an oscillator that provides information about the speed, change, and, thereby, strengths of price movements. It is visualized as a line graph that moves between two extremes, where 0 indicates that the asset is completely oversold (entry point) and 100 indicates that the asset is completely oversold (exit point).
Originally, the relative strength index indicator was described by J. Welles Wilder Jr. in 1978. Today, RSI is one of the most popular oscillators, widely used in combination with other indicators such as MACD and Bollinger bands.
The standard setting for the RSI is 14 periods, which means that the RSI evaluates the last 14 candles (i.e., time periods). The oscillator analyzes how many of the past 14 candles were bullish or bearish and takes into account the size of each candle. The more bullish candles there are and the larger the average gain is, the higher the relative strength index is.
Let’s take a look at an example from the Xena Exchange terminal. We’ve highlighted an area of 14 candles, where 13 candles are green (bullish) and only 1 is red (bearish). The RSI index chart indicates 85 in this case.
How to use the RSI indicator for day trading
In general, the RSI indicator generates a buy signal if it is less than 30 and a sell signal if more than 70. But in practice, a high RSI simply means that there were more bullish candles than bearish candles, and it never guarantees that a reversal will happen immediately. Let’s take a look at an example on a Xena Exchange BTC/USDT chart.
- The first area marks a very bullish period, with 5 bearish candles and 7 bullish candles. The RSI of this period was 84, which signals a bullish phase because the bulls outnumbered the bears.
- The second area features 6 bullish candles and 5 bearish candles, resulting in an RSI of 60, which signals moderate bullish strength, as the balance is nearly equal with just a slight bullish surplus.
- The third area features 6 bullish candles and 9 bearish candles. The RSI of this period was 25, which indicates a strong bearish movement because the bears were in control here.
But, as you can see, there’s no reversal after the RSI indicator showing 25 — so, it’s worth checking the RSI buy and sell signals with the help of other indicators. RSI works well with MACD and Bollinger bands — let’s have a closer look at how they do.
Powerful combination: RSI and MACD indicators
MACD — or moving average convergence and divergence — is a momentum indicator that shows the relationship between two moving averages, by default with a period of 12 and 26. MACD generates signals when it crosses above (buy signal) or below (sell signal) the signal line. The discrepancies between the MACD indicator and the price on the chart are called divergence and convergence, depending on whether the trend is bullish or bearish. They act as a powerful and reliable MACD signal for opening or closing a position.
Now, let’s take a look at how RSI and MACD work together. In the chart below, the green arrow shows the RSI touching 30, which is a buy signal. The red arrows show sell signals.
On the MACD sector, it is worth noting that the blue line crosses the red one at the first green arrow, which is a buy signal. The red signal, on the other hand, shows a sell signal.
RSI and Bollinger bands indicator trading strategies
Bollinger bands are a powerful indicator based entirely on statistics: averaging and standard deviations. Basically, they consist of three lines: a moving average and its value plus and minus the standard deviation. In this way, Bollinger bands create a channel and if the price goes beyond it, a buy or sell signal is generated.
The strategy of using RSI and Bollinger bands together means entering and exiting a position when both indicators show that the asset is overbought or oversold.
The red and green figures on this graph represent periods that could be good entry or exit zones according to RSI and Bollinger bands. The signals emerge when the price exceeds the lower or upper line of Bollinger bands indicator and the RSI indicator is extremely high or low.
RSI vs. Stochastic Oscillator
The stochastic oscillator is another highly popular trading indicator among professional traders. It is pretty similar to the RSI indicator, but there are differences. Its “normal” state is between 20 and 80, and if it goes above 80 or below 20, it indicates an oversold or overbought condition. If its parameter is over 50, that indicates the presence of bullish momentum, and a value below 50 represents bearish momentum.
The thing that traders need to know when choosing between the RSI and Stochastic is that the RSI is more applicable and accurate in trending markets, and Stochastic oscillator is more useful in sideways or choppy markets.
What is Stoch RSI?
Stoch RSI is an indicator of an indicator. It applies the formula of the Stochastic oscillator to the data of the RSI, not to the standard price data. It was developed to combine the benefits of both, but it can have brief disconnects from the actual price movement.
Understanding the Stock RSI indicator starts from its overbought and oversold zones. If the indicator is above 0.8, this is an alert that the asset is overbought, and if it’s below 0.2, it’s oversold. When using Stoch RSI in technical analysis, traders should be careful, as this indicator is extremely volatile. This results in many more signals generation, so traders can smooth the volatility be applying a moving average, among other measures.
RSI is a great and powerful tool, and when combined with other indicators, it can generate good buy and sell signals. Note that using a single RSI can create many false signals, so always check your suppositions. On the Xena Exchange blog, you will find many other stories devoted to technical indicators and analyses. Educate yourself, learn to read the charts, and improve your trading skills constantly. We wish you a good trading session!