Home Learn Articles Chat room
  About indicators The MACD indicator  

The RSI indicator

Stay up-to-date

Don't miss new content and revisions.

We don't spam nor share e-mails

Chat with our community!

Join our community chatroom: join the #thetradingdojo:matrix.org room on the app!

Created with Sketch. Get it on F-Droid. Download on the App Store.

On desktops:
Launch now on your browser

What does RSI stand for?

RSI stands for Relative Strength Index. It's a momentum oscillator, with a theoretical minimum and maximum of 0 to 100.

The RSI indicator

It can serve a variety of purposes:

It has been developed by J. Welles Wilder, who unveiled it to the general public in his book New Concepts in Technical Trading Systems in 1978. It's one of the most famous and used indicators.

What is the RSI formula?

For curious people, here is the way to calculate the RSI.
Don't worry, your charting software will do it for you: there is no need to understand or remember the formulas.

RSI formula

RSI formula

RSI formula

η by default is 14, you can modify its value in the options of tradingview.

Using the RSI to examine the momentum

It's one of the core usages of the RSI.
When there is a strong upside momentum, it can leads to overbought conditions. And reversely, in case of strong downside momentum, we can get an oversold market.

Conventionally, we say the market is overbought when its value is above 70, and oversold when its value is below 30.
As cryptocurrency markets are highly volatile, I personally use the levels of 75 and 25.

“Overbought”: After a strong bullish move, the numbers of buyers diminish as they get exhausted. The price begins to attract a higher number of sellers.
“Oversold”: After a strong bearish move, the numbers of sellers diminish as they get exhausted. The price drop makes the market interesting for buyers.

Let's take the overbought principle as an example.
A market with the RSI above 75 can mean two things:

In other words, the oscillator can be used to predict either:

With experience, you will develop your feeling and analysis skills. It will then be easy to distinguish which one of these two possibilities is going to play out. Let's take 4 examples:

Incoming reversal due to buyers exhaustion Incoming reversal due to sellers exhaustion

When the RSI reach 75, with some strength, but nothing crazy, a reversal is likely to occur:

Overbought signal RSI

See how the leg-up wasn't strong: it stopped as soon it touched the 75 line, then follow a few upper-wick dojis. The odds are against buyers.

When the RSI reach 25, with some strength, but nothing crazy, a reversal is likely to occur:

Oversold signal RSI

See how the leg-down wasn't strong: the lower wicks on red candles demonstrate a lot of buying pressure. Subsequently, the RSI tried to breach 25 again without success.

Indication of ferocious buyers Indication of ferocious sellers

If the RSI continues to rise strongly above 75, ideally 80, it means buyers are very motivated, and that there is a lack of offer: for some reasons, only a few are interested to sell.

However, a correction is due to happen, and only then the trend will be able to healthily continue its way.

RSI overbought condition signaling ferocious buyers

You should be cautious if you desire to get in the market while the RSI shows an overbought signal. Although it could continue to rise for a while, it's not the safest entry.

If the RSI continues to drop strongly below 25, ideally 20, it means sellers are very motivated, and that there is a lack of demand: for some reasons, only a few are interested to buy.

However, a correction is due to happen, and only then the trend will be able to healthily continue its way: you can see it on the following figure, the RSI had to shortly rise back to 25 before the price got more downside possibilities.

RSI oversold condition signaling ferocious sellers

The centerline: where is the market headed to?

The line at 50 can help you to determine the current trend.
A value above 50 can indicate that the market is bullish.
A value below 50 can indicate that the market is bearish.

This is a gross, imprecise indication: you shouldn't trade it by itself. It's only here to orientate your opinion.
Here is a chart where green parts indicate a RSI above 50, and red parts a RSI below 50.
Note how in 2018 it breached the centerline very briefly a few times.

The centerline of the RSI can indicate a bull or bear market

Divergences: lowering momentums

Divergences are another key principle of the RSI. They will show you that the momentum of a trend is weakening: a pause or reversal may happen soon.
A divergence doesn't call for an immediate action from your part to be taken. It is only a warning, a reminder to be careful.

Bearish divergence Bullish divergence

Bearish divergences happen in uptrends.

Bearish divergence RSI

On this chart, the price makes a higher high, while the RSI makes a lower high. The force pushing the price is becoming fragile.
Then follow a period of consolidation and a reversal.

Bullish divergences happen in downtrends.

Bullish divergence RSI

Here the momentum consistently weakens and the bear move ends with a bullish chart pattern (a double-bottom).
What define the divergence, is the price making lower lows, while the RSI makes higher lows.

Hidden divergences: momentums on pause

Hidden divergences indicate the continuation of the trend.
This hints you that further gains are on their way.
They usually happen while there is a little pause, some weak resistance, or in a consolidation. They are most likely due to profit taking.

Bearish hidden divergence Bullish hidden divergence
Hidden bearish divergence RSI

Bearish hidden divergences happen in downtrends.
The price makes lower highs, while the RSI makes higher lows.

Hidden bullish divergence RSI

Bullish hidden divergences happen in uptrends.
The price makes a higher low, while the RSI makes lower low.

Failed swings: trend reversal signal

Failed swings are occurrences that increase the potential for a reversal.
They are strictly dependent of the RSI only; the price does not enter into consideration.

Bearish failed swing Bullish failed swing
Bearish failed swing RSI

After having risen above 75, the RSI does a little pull-back.
It then tries again to rise, but stop before giving an overbought signal.
Thereafter, it falls below its previous low.

Bullish failed swing RSI

After having dropped below 25, the RSI does a little pull-back.
It then tries again to drop, but stop before giving an oversold signal.
Thereafter, it rises above its previous high.

Conclusion

Four decades after its creation, the RSI is still considered a staple indicator by many.
It's a powerful tool and one of my personal favourite.
The most common signals you will get from this oscillator are the oversold/overbought conditions, along with standard divergences.

Exercises

  1. Find 3 occurrences of a bullish divergence.
  2. Find 3 occurrences of a bearish divergence.
  3. On the daily, find 3 occurrences of an oversold market. Watch how it looks on the 4H and 1H charts.
  4. On the daily, find 3 occurrences of an overbought market. Watch how it looks on the 4H and 1H charts.
  1. Change the default period value of the RSI, try bigger and smaller configurations. Notice the transformation: does it get more or less reactive? More or less useful? (In the end, I advise you to keep the default 14 period)
  2. Change the value of the horizontal overbought/oversold limits. Try with 70-30, 75-25, 80-20. Try them on different time-frames.

Comments

Should you have any question or remark, feel free to post it. I will answer you as soon as possible!


I want to receive cool and useful mails from The Trading Dojo
We don't spam nor share e-mails

  About indicators The MACD Indicator