Trading 101: Relative Strength Index

Reading Time: 2 minutes

BitStarz’s Trading 101 series demystifies the world of trading and offers information and tips on the basic tools and indicators you need to get started in trading. By using them in conjunction with other indicators, and your trading style, you can trade any asset or commodity profitably, not just crypto.

What is the Relative Strength Index?

The relative strength index (RSI) was developed by J. Welles Wilder Jr. and outlined in his seminal 1978 book, New Concepts in Technical Trading Systems. The RSI is a momentum-based indicator that measures the magnitude of recent price changes to evaluate whether an asset is overbought (about to top out) or oversold (about to bottom out). The RSI is has a reading of 0 to 100 between which the line oscillates, as in the below image.

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When used in conjunction with a price action chart, the parallels are clear:

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Traditionally, an RSI value of 70 or above indicates that an asset is becoming overbought or overvalued and a corrective pullback in price may be on the cards. This can be demonstrated in the chart above, where the RSI for BTC/USD hit 94 as the price reached $19,000 in December 2017, before it plummeted almost 50% in the following three days.

Conversely, an RSI reading of 30 or below indicates that the asset is oversold or undervalued – BTC/USD hit 9.9 in November of 2018 and, while a month of further selling followed, the price action began to reverse swiftly afterwards. Interestingly, these two instances represent Bitcoin’s highest and lowest historical RSI values.

What is Stochastic RSI?

The Stochastic RSI indicator (Stoch RSI) can be considered an indicator of RSI, rather than an RSI itself. Created by George Lane in the late 1950s, stoch RSI compares a particular closing price of an asset to a range of its prices over a certain period of time, based on Lane’s belief that prices tend to close near their highs in bullish markets and near their lows in bearish ones.

Stochastic oscillator charts generally consist of two lines: one reflecting the actual value of the oscillator, and one reflecting its three-day moving average. Because price is thought to follow momentum, when these two lines intersect it is often indicative of an imminent reversal, given that it indicates a large shift in momentum from day to day.

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Like RSI, the Stoch RSI line oscillates between 0 and 100, with 20 and 80 being the key points to indicate oversold and overbought conditions.

Limitations of RSI

Seeing as it uses price momentum, RSI signals are most reliable when used in conjunction with a long term trend. They seldom indicate a true reversal, and can sometimes swing between high and low points with little change in price. An RSI can also stay in an oversold/overbought state for a long period of time during strong price momentum, leading to buying and selling an asset before it has concluded its run.

RSI and Stoch RSI are useful in offering a different perspective of an asset, but be careful not to trade on every swing and only use it in conjunction with other indicators as well as assessing the prevailing momentum of the asset.

We hope you found our guide on RSI useful. Next week’s Trading 101 will cover the MACD, so stay tuned!

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