Price action is the most direct technical analysis tool for trading cryptocurrencies. Support and resistance lines, and trendlines, are the next most direct tools for analyzing price movement. Relative Strength Index (RSI) is an indirect tool for analysis, since it is a momentum indicator that measures the speed and rate of recent price changes.
RSI is the creation of J. Welles Wilder who wrote about it in his book, “New Concepts in Technical Trading Systems,” published in 1978. This tool is useful to identify whether an asset is in the overbought territory, meaning the price might go down, or in the oversold territory, meaning the price might go up.
The RSI appears in the form of an oscillator with a value that ranges between 0 and 100. When the oscillator is in the area above 70, then it indicates that the asset is in an overbought condition and that the price might reverse down. When the RSI is in the area below 30, then it indicates the asset is oversold and price might reverse up.
The complete formula for calculating RSI can be found in Wilder’s book, but the basic formula is as follows. It is usually calculated within a 14-day period:
RSI = 100 — [100 / (1 + (Average of Upward Price Change / Average of Downward Price Change)]
Using the RSI in Trading
The standard threshold levels are 70 for identifying overbought conditions and 30 for oversold conditions. However, if a crypto asset is constantly above the 70 threshold or below the 30 threshold without a significant change in price direction, then we can move the threshold above 80 or below 20 to obtain more accurate trading signals.
In very strong bullish or bearish trends, the price of a crypto asset can continue climbing up even though the RSI is in an overbought condition or continue falling down when the RSI is in an oversold condition. That’s why this momentum indicator is best combined with other technical analysis tools, such as support and resistance and also moving averages for a more accurate reading.
During bull markets, the RSI thresholds tend to behave differently. If the trend is bullish, then the RSI fluctuates between the 40 and 90 range with support levels in the 40 to 50 range. If the trend is bearish, then the RSI moves in the 10 to 60 range with the resistance levels in the 50 to 60 range.
Other than using these ranges, the RSI can also produce a divergence. A divergence occurs when the price movement is different then the movement of the RSI. If the price of a cryptocurrency hits a new high but the RSI doesn’t show a new high at the same time, then this divergence can signal a reversal in the price movement.
A bullish RSI divergence occurs when the price of an asset is going down but the RSI is actually going up from the lower ranges. A bearish RSI divergence occurs when the price of an asset is climbing up but the RSI is going down from the higher ranges. A trader can use these divergences to properly long or short the asset.
Analyzing the RSI for ICP on BigoMex
A simple example of using RSI for trading of Internet Computer Protocol (ICP) on BigoMex is shown in the chart. During late July 2021, the RSI went into an overbought territory, signaling a price reversal may occur. As shown in the price movement, after that top, the price of ICP went from $59 to $26 over the course of a few weeks.
That said, the simple analysis of using RSI to identify overbought and oversold moments aren’t always accurate. It is best to combine them with one or two more technical analysis tools to get a strong assessment of where the price is going to go.
