How to Calculate Relative Strength Index and What are the Advantages?

The Relative Strength Index (RSI) is a technical indicator that measures the magnitude and speed of change in an asset’s price. Learn how to use this indicator to gain an edge in trading and investing in crypto.

Introduction — What is the RSI indicator?

The RSI or Relative Strength Index is a momentum indicator (an oscillator) that reflects an asset’s strength or weakness. RSI measures the change between the uptrend or downtrend of the price of an asset.

Momentum indicators are technical analysis (TA) tools used to analyze trends derived from past market price data. RSI and MACD (Moving Average Convergence Divergence) are some of the most commonly used momentum indicators.

How does the RSI work?

The RSI ranges from 0 to 100, with 0 being the lowest and 100 the highest. A reading above 70 suggests that the asset may be overbought and possibly ready to reverse. Conversely, a reading below 30 suggests that the asset may be oversold, and perhaps set for a rally.

On the Weekly Bitcoin Chart, the RSI (oscillator) reached overbought levels in its run from late 2020 to Q1 2021 while it breached the oversold levels in June 2022.

The RSI is most often used on a 14-day (or 14 bars) timeframe, and it is calculated by taking the average of each day’s high, low, and closing prices, divided by their respective values from the previous day. It can also be calculated using a 2-day or 8-day timeframe. The indicator can identify overbought or oversold conditions in an asset’s price relative to its trend and volatility.

How to Calculate Relative Strength Index for Multiple Timeframes Simultaneously?

Created by J. Welles Wilder Jr in the 70s, The RS value is calculated by taking an average between up closes over down closes of the asset.

RS = Average of X days’ up closes / Average of X days’ down closes

By getting the RS value, you can now compute the RSI value of an asset, with parameters depending on the selected time frame (4 hours, one day, etc.).

RSI = 100 -(100/1 + RS)

Since most analytic tools include RSI as a basic indicator, you can skip the calculations above and adjust your preferences starting from these parameters:

  • Length of RSI: 14 bars
  • Overbought level: 70
  • Oversold level: 30

The Importance of using the RSI in Your Trading Strategy

Since RSI is a momentum indicator that tracks the divergence of trends, it can also be combined with other TA tools (Volume, Moving Averages, etc.) to strengthen your decision to invest in an asset.

Divergence in a trend occurs when the RSI indicator shows us a contrary direction of the price which can signal:

  • The trend is weakening which can start a correction
  • The end of the current trend which could reverse or consolidate for a period of time

By combining the parameters and the divergence of RSI and price, we arrive at two (or more) possible scenarios:

  1. Bullish divergence: The trend of the price makes a lower low while the oscillator forms a trend of higher lows, starting from the oversold levels.
On the Daily Chart, Bitcoin’s price made a lower low between May and June 2021 while the oscillator made a higher low starting from the oversold levels. This reversal move resulted in more than 100% return, starting from the Support line of $30K to the Resistance of $60K and above.

2. Bearish Divergence: The trend of the price makes a higher high while the oscillator forms a trend of lower highs, ideally starting from the overbought level.

On the Weekly Chart, Bitcoin’s price made a higher high (HH) from January to November 2021, while the oscillator (measured in 14 bars) made a lower high (LH) from the same period, which indicated a weakness in a trend that resulted with a -69% return.

Conclusion

On Taking Risk: “Never test the depth of the river with both feet”
-Warren Buffet

By combining the RSI tool with the Japanese Candlestick chart pictured above alongside other TA indicators, one can increase the probability of predicting the next direction or the reversal of the trend of a cryptoasset.

Learn more about the Relative Strength Index and other Technical Analysis tools by signing up on our website.

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Disclaimer: This article is for educational purposes only and must not be treated as financial or legal advice.

Please conduct due diligence and manage your risks accordingly.

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