Chart 101: Understanding and Trading with the RSI

On several occasions, you must have heard of RSI saving the day or RSI showing the way. The RSI is neither a prophet nor a fortune teller. It’s merely an indicator. In my previous lesson was on Ultimate Guide for Trading Altcoins using the Coin Market Cap, today I will be discussing the RSI.

The Relative Strength Indicator, or RSI, is a popular indicator developed by a technical analyst named J. Welles Wilder.

The RSI is an oscillator indicator, meaning that it points out overbought and oversold conditions. It can also help confirm a trend and in here we will explore extensively its functions. If you trade the financial market, then you should that ability to confirm the trend on the market is gold because if you can do that, you will know when to buy and sell for profit.

 

RSI Setup

The RSI works like the regular pendulum or alternating waves.

It moves to and fro, or back and forth within 0 and 100. To determine this a formula is used.

RSI, RSI FORMULA, STOCHASTIC, PARABOLIC SAR, DIVERGENCE, REVERSAL, SUPPORT, RESISTANCE

I hope you are not getting scared thinking you will have to make such calculation before you can even predict a move. Trust me, even if you are a guru the trend would have left you behind before you are done solving.

So basically the calculation is already done for you by the indicator. The only thing you need to do is set the indicator period that best suits your trading style.

The most common periods used on the RSI are 14 and 21. These figures signify the timeframe. The bigger the time frame, the more data is used in the calculation and that makes it less reactive. In other words, the RSI 21 is going to have fewer target areas than the RSI 14. A smaller time frame is going to be beneficial if you are day trading, while a larger time frame will be beneficial if you plan on buying and holding a coin.

 

How to Trade Using RSI

I personally use RSI in my trades. I use it for signals and then confirm the signal with other indicators. Another little secret of mine is that I use the RSI to determine strong support and resistance levels. If you want to know this crazy secret, then read on.

The RSI indicator ranges between 0 to 100 but it’s usually calibrated at level 30, 50 and 70. These 3 levels are the most significant RSI levels. Don’t panic because you will know why soon.

RSI, RSI FORMULA, STOCHASTIC, PARABOLIC SAR, DIVERGENCE, REVERSAL, SUPPORT, RESISTANCE

 

1 Overbought/Oversold Signals

When the RSI is above the 70 level, it’s believed to be overbought, and when it’s below the 30 level it’s believed to be oversold.

RSI, RSI FORMULA, STOCHASTIC, PARABOLIC SAR, DIVERGENCE, REVERSAL, SUPPORT, RESISTANCE

In cryptocurrency trading, you are expected to buy at the dip and sell at the rise. In the above chart, the green circled areas are the oversold area (dip). You will notice that after the dip (cross below the 30 level) there is a rise in price.

Note: The indicator does not show when to either buy or sell, but gives an idea of what the next price direction is likely to be.

 

2 Trend confirmation

Whenever a dip occurs, and a continuous rise is detected, a movement above 50 level confirms an uptrend, while a movement below the 50 level confirms a downtrend.

RSI, RSI FORMULA, STOCHASTIC, PARABOLIC SAR, DIVERGENCE, REVERSAL, SUPPORT, RESISTANCE

 

3 Reversal Trading

Reversal trading has proven to be one of the safest trading strategies. Trading reversal is basically and generally known as DIVERGENCE when using oscillator indicators.

RSI, RSI FORMULA, STOCHASTIC, PARABOLIC SAR, DIVERGENCE, REVERSAL, SUPPORT, RESISTANCE

 

Notice the reverse price movement after the divergence. It dropped +60% after the divergence.

I won’t delve more into this as divergence itself is a mind blower and deserves the honour of a whole treat.

 

4 Support and Resistance

Just like in the QFT strategy, the overbought and oversold levels are strong support and resistance levels.

 

Conclusion

The RSI is a good indicator for both day trading and swing trades. However, I recommend confirming the overbought and oversold signals with the 100 periods;;/; moving average indicator when trading trends; this may not apply to reversals.

Keep watch as I will be explaining the uses of moving averages, MACD and how they can point reversals.

Update: The Moving Average Lesson is ready, Click here to read

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