There is a group of market theorists who believe that — although individual investors may behave randomly — the market as a whole will always be efficient or fair. The Efficient Market Hypothesis, or EMH for short, implies that it is impossible for crypto traders to buy undervalued assets or sell them at extremely inflated prices.
However, fundamental analysts believe that the market is as irrational as those participating in it. Hence, it is possible to sniff out undervalued and overvalued assets.
The Relative Strength Index, or “RSI” for short, is a momentum indicator used to measure the rate of recent price changes. Market analysts and crypto traders use the RSI, along with other technical indicators, to evaluate overbought or oversold conditions. This provides buy or sell signals when the asset is oversold or overbought respectively.
This is how the RSI is calculated. You take the average gain and divide it with the average loss. Add 1 to the value and divide it by 100. Finally, subtract 100 with the value — and there is your RSI.
Now, you have nothing to worry about. Most online crypto trading charts have already done the calculations for you, so all you have to do is toggle the RSI chart view on.
Typically used on a 14-day timeframe, the RSI is measured on a scale of 0 to 100. If the value is 70 or above, the asset is considered “overbought” or “overvalued”. This suggests that the asset is being traded at a higher price than its true worth. Overvaluation may be caused by emotional trading, which significantly drives up the market price.
If it’s 30 or below, then it’s considered “oversold”. It implies that the asset trades at a price below its intrinsic value. This means that it’s worth much more than the price that it’s trading at in the market.
Any value between 30 and 70 will be considered neutral.
It is a bullish sign when the RSI exceeds 30, and when it goes below 70, it is a bearish sign. An alternative way of putting it would be interpreting the RSI value of 70 or above to be an indication that the asset is overbought and that a trend reversal may be imminent.
On the other hand, if the downtrend could not reach 30 or below and instead shoots to 70 above, it suggests that the trend is reversing.
When the price of an asset is moving against the direction of the RSI, we call that a “divergence”. A divergence warns that the current price trend is losing steam and may lead to the price heading in the opposite direction. Or it can also signal a possible trend continuation.
Here is how you spot a divergence. Display both the candlestick graph and the RSI graph together for comparison.
Then, draw a trend line from the highest high or lowest low to the previous highest high or lowest low. Notice how the trend lines do not move in the same direction. The trend line of the candlestick graph moves up while the trend line for the RSI graph moves down. This is known as a Regular Bearish Divergence.
You can see that the market goes bearish right after the divergence. Regular divergence tells you that the market may undergo a trend reversal. Whereas a hidden divergence signals a possible trend continuation.
While these signals are still valid, divergences can be especially rare when an asset is in a stable trend for a long time.
Like any form of technical analysis, crypto traders are advised to use a mix of different indicators and analysis techniques to help them confirm a trend reversal instead of relying on divergence alone.
And, even if a divergence occurs, it doesn’t guarantee that the price will definitely reverse or even in the near future. As it is possible for a divergence to last for a long time, it can be risky for crypto traders to act on it alone since that would lead to substantial losses.
Generally, RSI is a valuable technical indicator for crypto traders looking to identify overbought and oversold conditions and potential trend changes in the crypto market. It tends to be conveyed all alone or related to different indicators. A crypto trader can convey a simple to utilize crypto trading bot to execute a strategy in light of RSI.