The Relative Strength Index (RSI) is a momentum oscillator widely used in technical analysis. RSI measures the speed and change of price movements, providing crypto traders with valuable insights into potential market fluctuations. It oscillates between 0 and 100, with readings above 70 generally indicating overbought conditions and readings below 30 suggesting oversold conditions.
RSI calculation involves comparing the magnitude of recent gains and losses over a specified time period. This results in a single numerical value, which is usually plotted on a chart and visualized along the asset's price movement (see image below).
Let’s take a look at some reasons why traders use the RSI indicator.
1. Oversold and overbought conditions. One of the primary uses of RSI is to identify overbought and oversold conditions in the market. When RSI readings exceed 70, it suggests that the asset may be overbought, meaning it could be due for a correction. Conversely, RSI readings below 30 indicate oversold conditions, suggesting that the asset may be undervalued and could be poised for a reversal to the upside.
2. Divergences. Traders can also spot bullish and bearish divergences between RSI and price action. Bullish divergences occur when the price forms a lower low while the RSI forms a higher low (see image below). This suggests that despite the downward price movement, momentum is shifting upwards, indicating a potential trend reversal to the upside.
Conversely, bearish divergences occur when the price forms a higher high while the RSI forms a lower high (see image below). This signals potential weakness in the prevailing trend.
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