Cryptocurrency markets can be extremely difficult to understand, especially with more experienced stock traders entering the market each day. One way to enhance your understanding of how a particular currency is moving on the market is through technical analysis.
Technical analysis relies on historical data to indicate potential trends, and multiple metrics can be calculated to inform your viewpoint.
One of the most common and powerful technical indicators or metrics used across stocks and cryptocurrencies alike is the relative strength index, or RSI. RSI identifies differences between price and demand, allowing smart traders to buy or sell depending on the signal.
What is the relative strength index?
RSI is a metric that outputs a line over time. This line ranges between 0 and 100, and different slopes and cutoff values can have important meanings for traders. RSI is calculated by using historical data from a time period prior to the current day (usually 14 days), including data like average price over that time, high, low, and range.
The calculation is performed through two different formulas, but many calculators exist online that output RSI by simply plugging historical data in. RSI is usually plotted underneath a boxplot chart of price in order to understand divergence between RSI and price.
This technical indicator provides some very simple signals to look for. For example, an RSI value over 70 generally signals that the stock is overbought and that traders should sell. Similarly, a value under 30 indicates the stock is oversold and should be bought. Different traders will tweak these values, with safer traders using stronger values of 85 and 15 to ensure the signals are actually present.
Single values aren’t the only reason to use RSI, however. Because RSI is plotted as a line over time, it’s easy to tell when the RSI is trending in an opposite direction from the stock’s price.
If RSI is increasing as the price is dropping, this indicates a bullish divergence and price is likely to increase again. It’s far more common to see a bearish divergence though, where price is increasing but RSI is decreasing rapidly.
How can the relative strength index be used for cryptocurrency?
By keeping a close eye on overbought and oversold signals, along with differences between RSI and price trends, you may be able to spot unique opportunities for certain cryptocurrencies. It’s important that you don’t just calculate RSI with daily prices or weekly prices – RSI can be calculated with hourly data as well.
By looking at price and RSI across different timescales, you could see different price trends emerging as different areas of the world trade crypto more. The same overbought and oversold signals apply to cryptocurrencies as they do to stocks, but you may want to tweak the cutoff values to your personal preference.
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DRIVE Insider is not an investment advisor. We do not provide personalized recommendations or views as to whether a cryptocurrency or investment approach is suited to the financial needs of a specific individual.