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How to use the RSI indicator to find entries and exits when trading cryptocurrency

In Trading

RSI, short for “relative strength index”, is one of the most popular indicators used by traders (margin traders and day traders alike) to find profitable entry and exit prices.

RSI is a momentum-based indicator that compares an asset’s current strength with that of a previous period. Most traders use a period setting of 14, which means closing price data from the past 14 periods (15m, 30m, 1h, 4h, etc) will be used to calculate RSI.

RSI oscillates between 0 and 100. If an asset’s RSI value drops below 30, it is considered oversold, while a RSI higher than 70 indicates overbought conditions.

An asset that is oversold is believed to be trading under its true value, and has a high probability of rebounding to the upside in the otherwise normal market conditions.

Conversely, an overbought asset is one that trades at a premium and has a high probability of correcting to the downside.

On a macro level, RSI is also an indicator of bear and bull market conditions. In a bear market, RSI typically ranges between 10 and 60, with 50-60 acting as a resistance range.

In a bull market, RSI often moves between 40 and 90, with 40-50 acting as a support range.

How to set up RSI on Liquid

RSI is a very useful indicator that has the potential to bring a lot of clarity to seemingly random price movements.

We’ll be taking a look at some charts later on in this post, so let’s quickly go over how to set up the RSI indicator in case you want to follow along on a live chart.

First, head over to Liquid and select a trading pair. We’ll use BTC/USD for this example. Click on the indicators icon to bring up a search box, type RSI, and click on “Relative Strength Index”.

To get a better view, expand the chart to fullscreen mode. You should now see the RSI indicator under the candlestick chart. By default, the RSI indicator charts a thin purple line which can be difficult to see. To fix this, click on the Format button.

Under the “Style” tab, click on “Plot” to select a different color and drag the line thickness toggle to make the RSI chart more visible. In the images below, we changed the plot color to pure white and selected the maximum line thickness.

Reading and interpreting RSI

By default, the RSI indicator on Liquid charts display oversold and overbought thresholds of 30 and 70, respectively.

As you gain more trading experience and become familiar with an asset’s volatility tendencies and patterns, you may find it necessary to change these thresholds. For now, the default setting is a good starting point.

The image below shows a 4-hour chart of BTC/USD from mid-August to late-September. On the RSI chart, A is an example of overbought conditions at RSI 75, while B indicates oversold conditions at RSI 25.

Identifying RSI Divergences

A divergence occurs when price action is not adequately supported by trading volume in the same direction, and indicates a high probability price reversal. As a result, price and RSI diverge into opposite directions. There are two types of RSI divergence - bullish and bearish. A price decrease with RSI increase is a bullish divergence, while a price increase with RSI decrease suggests a bearish divergence.

Here’s an example of a bullish divergence” The yellow arrow shows a price decrease, while the purple arrow shows an RSI increase. In this situation, exhausted bears are unable to keep the sell volume going, and price reverses to the upside. Bullish divergence is often used as a confirmation signal to buy an asset or open a margin long position.

In this bearish divergence example, a yellow arrow shows a price increase, while the purple arrow shows an RSI decrease. In this situation, bulls are unable keep sustain buying momentum, and the price reverses to the downside. Bearish divergence is often used as a confirmation signal to sell an asset open a margin short position.

Identifying macro trends

RSI can be used to determine the macro trend of an asset. In a bear market, RSI tends to fluctuate between 10 and 60, with 50-60 acting as heavy resistance. In a bull market, RSI moves between 40 and 90 with 40-50 acting as strong support. To view these long-term trends on a chart, it’s best to use a weekly or monthly time frame. Here’s a weekly chart of BTC/USD with the RSI indicator enabled. The green overlay shows the bull market support range, while the red overlay shows the bear market resistance range.

A shows a very strong bounce off the bull market support range and is a high probability signal of an impending bull market. On the other hand, B indicates a clear break of support at RSI 50 in April. Following the support break, the RSI 50 range becomes a level of resistance which is tested again in May and August, ultimately resulting in two strong confirmations of a bear market.

Leveraging RSI for Margin Trading

In normal spot trading, it’s only possible to profit on one side of the trade in terms of the denominating currency.

For example, buying 1 BTC at $6500 and selling it $7000 yields a profit of $500. After you sell, it’s not possible to profit off of a subsequent drop in USD terms.

The same logic can be applied to the RSI indicator. When spot trading in a reasonable time frame, it’s possible to profit from buying in oversold regions and selling in overbought regions.

There’s no problem with only playing one side of the trade and it’s a completely valid strategy, but giving yourself exposure to both sides of the playing field could result in more profits or help you recoup after an unprofitable trade.

In order to profit off a bearish divergence in terms of the denominating currency, you’ll need to open a short position which is only possible on Liquid via margin trading - borrowing an asset to sell in overbought regions, rebuying the asset in oversold conditions, and returning the loan and pocketing the difference as profits.

Conclusion

RSI is a very powerful tool for finding high probability entries and exits, especially when trading on leverage. Combining RSI with price action analysis, EMA strategies, and patience can form a strong foundation for further development. Head over to Liquid and experiment with how the RSI indicator can make your margin trading strategy more profitable today.

Trade crypto on Liquid

This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.

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