RSI or relative strength index is one of the most commonly used indicators in crypto trading. It is a perfect indicator for timing the market for opening and closing your positions. RSI in crypto trading works best with other indicators and chart patterns. We made a case study with various possible usage of this indicator and hope this will be useful for trading strategy.
In this article we continue our series of articles on crypto trading.
What is RSI in Crypto and how is it calculated?
RSI or relative strength index is an oscillator that shows when price is overbought or oversold. It shows price momentum. Index goes from 0 to 100. 70 and above usually means that commodity is overbought, 30 and below means that commodity is oversold.
You can calculate RSI meaning with following two step formula:
Taken from Investopedia.com
Most commonly used RSI is 14 or 21 periods. This means the index shows previous 14 or 21 candles levels.
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How to use RSI in crypto trading?
In crypto trading RSI signals are used for opening and closing positions. Traders rarely use RSI alone in their trading strategies. In most cases to get a signal confirmation traders use other indicators or chart patterns.
There are many ways to use RSI in your crypto trading and below we took a good look at some real life cases.
Naked RSI
Relative Strength Index shows “overbought” and “oversold” zones of cryptocurrency. Traders look for those zones trying to open a position that is opposite to the market right at the peak or bottom.
When the price of crypto is falling sharply the strategy metaphorically is called “catching the falling knife”. Meaning that when you are trying to catch a falling knife you either will catch it by the handle or by the blade. So, you will catch the knife or will have a bleeding hand.
Example of “falling knife” and how RSI helps to find the bottom.
But RSI will show many fake signals if used alone:
Example of fake signal. Fake bottom followed by minor bounce and then price continues falling lower.
This example shows that RSI on its own will show many signals out of which only few will be profitable. So, the goal of our case study is to find the best way to use RSI and filter out most of the fake signals.
RSI + Chart patterns
One of the ways to use RSI in crypto trading is with chart patterns. In the example below RSI + double bottom formation is shown, right after a fake signal from RSI.
In this case double bottom formation acts like a confirmation of the signal.
Pinbar
Pinbar is another common chart pattern. It shows possible market turn around points. Pinbars have long tails and short bodies. In this example pinbar is used to confirm a signal from RSI.
RSI + Bollinger Bands
Bollinger Bands (BB) is one of the most popular indicators in trading. You can read more about it in our crypto indicators article.
BB can help to filter out bad signals of the RSI. BB is a trend indicator and if the price is outside the upper or lower line this means trend. On the other hand, RSI is an oscillator and is meant to show where the trend turns around.
So, if the price of the crypto is outside the upper or lower BB line, then this could mean a strong trend and in this case we consider RSI signals as fake.
And vice versa, if BB shows no trend, we consider RSI signals as market turn around points. Example of this setup below.
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Timeframes
Timeframes is another important topic when discussing crypto trading indicators. In our examples we used timeframes from H1 to D1. These are probably the most popular timeframes among crypto traders to use RSI.
Conclusion
RSI is a very common oscillator. Many traders use it to find profitable trades and to catch trends before they even begin. In reality RSI alone gives lots of fake signals. So, crypto traders combine several indicators in order to filter out bad signals. Chart patterns, Bollinger Bands, MACD, Stochastic and other indicators could be used together with RSI. So, it is up to you to find the best strategy that fits RSI indicator the best.