Relative Strength Index, usually abbreviated to RSI is a useful indicator of whether a particular cryptocurrency is overbought – overvalued – or oversold – undervalued.
It is what is known as an Oscillating Index, as it returns a value on a scale from 0-100. An RSI value above 70 tends to suggest overbought conditions, while a value below 30 that a cryptocurrency is undervalued from excessive selling.
The RSI calculation is quite simple, essentially looking at days when the price gains in relation to those where price falls. It is calculated with this formula:
RSI = 100 – 100 / (1 + RS)
RS is the average increase in price over 14 unit periods / average decrease in price over the same period. A unit could be a day or hour.
In this way RSI is a measure of momentum in the market but if it was as simple as waiting for the RSI to hit 70 or 30 and sell or buy accordingly we would all be very wealthy.
Below is an example RSI seven day chart for BTC/USD on March 16th, 2021.
- Notice the way that the linear price is in the top pane
- RSI appears in a pane below with the key thresholds of 70 & 30 plotted
- RSI correlates relatively closely to price and its highest point of 74 on March 14th acts as leading indicator for the subsequent drop in price.
Markets can support overbought and oversold conditions depending on other contributing factors so RSI shouldn’t be relied on in isolation. It is what is known as a Leading Indicator, an indicator of where price might be about to go.
Moving Averages are an example of a Lagging Indicator, an indication of historic pattern or confirmation of a trend.
The next article in this section on how to trade cryptocurrency will look at leading and lagging indicators in more depth, including information specific to the functioning of cryptocurrencies and the wider ecosystem that provide useful information to inform trading.
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