Let’s simplify things step by step to understand the Relative Strength Index (RSI): What is the RSI? The Relative Strength Index (RSI) is a technical analysis tool used to determine whether a financial instrument (such as a cryptocurrency or stock) is overbought or oversold. Its value ranges from 0 to 100.
How does the RSI indicator work?
1. Select the period: RSI is usually calculated over 14 time periods (this period can be daily, weekly, or other depending on your usage).
2. Calculate the profit to loss ratio (RS): Calculates the average profit and average loss over the selected period.
Average profit: Total profit in periods of rising price divided by the number of periods.
Average Loss: Total losses in periods of falling price divided by the number of periods.
3. Calculate the RSI using the following formula:
\[
RSI = 100 - \left(\frac{100}{1 + RS}\right)
\]
Where RS is the ratio of average profit to average loss. How do you interpret the values?
- RSI above 70: May indicate an overbought condition and a price correction may be imminent.
- RSI below 30: May indicate an oversold condition and there may be a buying opportunity soon.
- RSI between 30 and 70: The market is considered relatively balanced.
Simple example:
If you are monitoring the price of a cryptocurrency over a 14-day period:
- In 8 days, the coin saw a rise and gain of $40.
- In 6 days, the currency saw a total decline and loss of $20.
- **Average profit**: 40/8 = $5.
- **Average loss**: 20/6 = $3.33.
- **RS**: 5/3.33 = 1.5.
- **RSI**:
\[
RSI = 100 - \left(\frac{100}{1 + 1.5}\right) \approx 60
\]
Therefore, the RSI is 60, which means that the market is relatively balanced.
I hope the explanation is clear.
