How to use the RSI indicator to trade cryptocurrency with Technical Analysis vs. Game Theory
What Is Relative Strength Index (RSI)?
RSI stands for Relative Strength Index and it is a momentum indicator that measures the strength of the price changes over a specified period of time (look-back period). These price changes coupled with its strength evaluate its overbought and oversold conditions. This is its strength relative to its price, hence the name “Relative Strength Index”.
RSI is a very versatile indicator and should be in every trader’s toolbox, especially when trading cryptocurrencies.
How is RSI calculated?
The calculation for RSI is a two-part equation, and for your viewing pleasure here is the formula:
The first part of the equation obtains the initial Relative Strength (RS) value, which is the ratio of the average ‘Up’ closes to the average of ‘Down’ closes over ‘X’ periods represented in the following formula:
RS = Average of ‘X’ periods closes up / Average of ‘X’ periods closes down
X = the period chosen for the calculation
Then the actual RSI value is calculated by indexing the indicator to 100, by using the following formula:
RSI = 100 – (100 /1 + RS)
The formula spits out a value that ranges from 0 to 100 which is visually represented on the charts in a wave pattern, otherwise known as an “Oscillator”.
Now that the boring the stuff is out of the way, let’s take a look at what the numbers mean in regard to Technical Analysis (TA).
How to trade cryptocurrency with RSI
The default look-back period for RSI is 14. RSI is considered overbought when its value is 70 or above. RSI is considered oversold when its value is 30 or below.
Overbought means that buying pressure has peaked and signifies that the price of the cryptocurrency will come back down. What goes up must go back down.
Oversold means that the selling pressure has peaked and signifies that the price of the cryptocurrency will go back up. What goes down must go back up.
Overbought and oversold also means that the cryptocurrency’s price is too far from its true value. Its true value is smack in the middle at 50.
Because RSI is a momentum indicator, it works best when the cryptocurrency is range bound, also known as “sideways”.
The chart pic below is of Bitcoin (BTC) on 15-minute candles using RSI of 14 periods. It shows when Bitcoin is range bound, overbought, and oversold.
So, as you can see from the pic above, when Bitcoin was oversold, the price went up, and when bitcoin was overbought, the price went down. Also, you will see that not all the overbought or oversold conditions caused the price to rise or fall dramatically. When RSI was much deeper in oversold territory (much less than 30), the price increased significantly. This affect is what is known as a greater pullback. The deeper the RSI is in oversold territory, the greater the pullback will be to its true value. The deeper the RSI is in overbought territory, the greater the pullback will be to its true value.
Do you remember what cryptocurrency’s true value is? The true value is 50. Always remember “smack in the middle”.
Theoretically, a trader can buy a position (enter a trade) in the RSI oversold territory and sell the position (exit a trade) in the RSI overbought territory. Or for the margin and leverage traders, go long when RSI is oversold and go short when RSI is overbought.
RSI Game Theory
Now let’s look at the game theory of RSI. Game theory is the game between the Bulls and the Bears. A battle of control. A game of “Mortal Kombat” with cryptocurrencies. Which one is going long, and which one is going short?
If we lengthen the RSI period to 21 and look at the assets true value of 50, we can get a better indication of who has control, the bulls or the bears.
In the above pic, on the RSI oscillator, the dotted line is RSI 50. From this pic, it shows that when RSI moves above the true value of RSI 50, the bulls have control and are going long. When RSI moves below the true value of RSI 50, the bears have control and are going short.
Remember that the deeper the value of RSI in overbought or oversold territory, the greater the pullback to its true value?
The same principle applies to this game theory, except it is with the value of RSI at 50 instead of overbought (70) and oversold (30). So, whenever the RSI value is deep inside the bull or the bear territory, the greater the pullback will be back to RSI 50 (true value). The true value is like a magnet that will always pull the price back to within a deviation of its range.
Theoretically, a trader can go long when RSI breaks to the upside of RSI 50 and go short when RSI breaks to the downside of RSI 50.
As traders, we capitalize on the movements away from the true range…and hopefully it’s to the upside. Just a little humor there. Of course, we always want to go to the upside. We want profits. What do we want? PROFITS. When do we want the profits? If you said “now”, that is correct, but in more detail, we want to take the profit before the price action returns to the cryptocurrency’s true value range.
I use a crypto trading bot. How do I set the indicator to perform the RSI Technical Analysis?
In the pic below, it shows how to set up the RSI indicator on the world’s fastest crypto trading bot, WolfpackBOT.
Navigate to “Strategies” and then go to “Indicator Settings”, and then scroll down to RSI. Enter the information that is in the pic and you will now be able to buy cryptocurrencies that are Oversold at RSI 30 or less and selling them when they are Overbought at RSI 70 or greater.
Food for thought, using only one indicator for trading cryptocurrencies, or any asset for that matter, is not the best move. We want to make sure that the price is going to go up and have the momentum to get it to where we want it to go. With that in mind, the better move is to use a combination of indicators to achieve your trading goals.
This may seem like a whole lot of information to absorb but learning Technical Analysis will help you up your game. You can trade manually by staring at charts all day long and placing orders yourself on exchanges one cryptocurrency at a time, or you can use the world’s fastest crypto trading bot and trade all of the cryptocurrencies at the same time.
Download the WolfpackBOT now and get a free 7 day trial.
- The default look-back period for RSI is 14, but the period can be lowered to increase sensitivity or raised to decrease sensitivity.
- A quick rally to the upside usually happens after a severe price drop, which is known as an “oversold bounce.” Using RSI to make entries (buy orders) during an oversold bounce can be a very effective way to achieve profit.
- Do not wait for RSI to reach oversold of 0 or overbought of 100 because it is a very rare occurrence. An RSI value greater than 85 represents extreme overbought conditions, and an RSI value less than 15 represents extreme oversold conditions.
- A divergence is when RSI begins to establish a trend that disagrees with the actual price movement.
- A “bullish divergence” occurs when RSI is making higher lows (becoming less bearish) while the price action itself is making lower lows. This represents investor sentiment and is indicating that the market is overextended or “oversold” to the downside. In layman terms, RSI is getting higher while it is still down-trending and the price is still going down. This means the trend is going to reverse and the price is going to go up.
- A “bearish divergence” occurs when RSI is making lower highs (becoming less bullish) while the price action itself is making higher highs. This represents investor sentiment and is indicating that the market is overextended or “overbought” to the upside. In layman terms, RSI is getting lower while it is still up-trending and the price is still going up. This means the trend is going to reverse and the price is going to go down.
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WolfpackBOT and EvolV links
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