RSI: The Essential Indicator to Optimize Your Trading in Crypto Markets

What is the Relative Strength Index (RSI)?

Technical analysis (TA) forms the basis for predicting future trends by studying historical market movements. In both traditional financial markets and cryptocurrency markets, traders use specialized indicators and analytical tools to identify patterns that may signal upcoming price movements.

The Relative Strength Index (RSI) is a technical indicator developed in the late 1970s as a tool for analyzing asset performance over specific periods. It essentially functions as a momentum oscillator that measures both the magnitude and the speed of price changes. Due to its versatility and effectiveness, the RSI has become a widely used tool among traders and technical analysts across various markets, including cryptocurrencies.

In 1978, J. Welles Wilder, a mechanical engineer who redirected his analytical skills towards technical trading, created this indicator. Wilder had started his financial career in the real estate sector during the 1960s. After selling his stake in the business in 1972, he invested his $100,000 in profits in the stock market, which led him to develop reliable tools for identifying profitable patterns. In 1978, he compiled his research and experience into mathematical formulas and indicators for traders' use, with the RSI being one of his main contributions to modern technical analysis.

Functioning of the RSI Indicator

The RSI by default evaluates price changes over 14 periods (14 days on daily charts, 14 hours on hourly charts, etc.). The formula calculates the ratio of average gains to average losses during that interval, presenting the result on a scale adjusted between 0 and 100.

As a momentum indicator, the RSI measures the rate of price change. An increasing momentum indicates that the asset is being actively bought, while a decrease suggests that traders' interest in the value is waning.

The RSI also serves as an oscillator indicator that helps detect overbought or oversold market conditions. On a scale from 0 to 100, considering the standard 14 periods, an RSI level of 30 or below suggests that the asset is likely near its floor (oversold), while a reading above 70 indicates that the price may be close to its ceiling (overbought) for that time period, anticipating a possible drop.

Although the default setting is 14 periods, traders can adjust this parameter to increase sensitivity (less periods) or decrease it (more periods). For example, a 7-day RSI will respond more quickly to price fluctuations than a 21-day one. In short-term trading, many traders modify the overbought and oversold levels to 80 and 20 respectively (instead of 70 and 30), to reduce the likelihood of receiving false signals.

RSI Divergences: Advanced Signals

In addition to using levels 30 and 70 to identify oversold and overbought conditions, traders also leverage the RSI to predict trend changes or detect support and resistance levels through so-called bullish divergences (bullish) or bearish divergences (bearish).

A bullish divergence occurs when the price of an asset moves in one direction while the RSI indicator moves in the opposite direction. Specifically, the RSI begins to form higher lows (higher lows) while the price continues to make lower lows (lower lows). This bullish divergence indicates that momentum is strengthening despite the decline in price, which could anticipate a trend reversal.

On the contrary, bearish divergences can indicate that the market is losing momentum despite the increase in price. In this case, the RSI forms lower highs ( while the price continues to make higher highs ).

It is important to highlight that RSI divergences are not usually reliable during strong market trends. A persistent bearish trend may show multiple bullish divergences before reaching its true bottom. For this reason, RSI divergences are more effective in markets with low volatility, characterized by sideways movements or moderate trends.

Practical Application of RSI in Trading

To effectively use the Relative Strength Index, traders must consider several key factors such as the indicator setup, critical levels (30 and 70), and bullish/bearish divergences. However, it is essential to remember that no technical indicator is infallible, especially when used in isolation.

Experienced traders integrate the RSI with other technical indicators to confirm signals and avoid false alerts. For example, the combination of the RSI with moving averages or the MACD (Moving Average Convergence/Divergence) provides a more comprehensive view of the market and reduces the risk of erroneous trades.

In cryptocurrency markets, characterized by their high volatility, the RSI can be adjusted to fit specific conditions. Some traders modify the periods of the RSI or the overbought/oversold levels according to the historical behavior of each crypto asset or the phase of the market cycle.

When implementing strategies based on the RSI, it is essential to contextualize the signals within the overall market framework, paying attention to both the timeframe in which one operates and the prevailing trend in higher time horizons.