As mentioned before, you only need one type of indicator. So, if you’re using both the RSI and the Stochastic RSI, you’re wasting your time. They both are leading(1) momentum(2) indicators that look at the same thing — is a crypto oversold or overbought? Therefore, you just need one. Study the both of them or another momentum indicator that makes the same determination and choose one.
Understanding How and When to Use the Indicator
I tried to bold two important keywords above to help you out. Let’s sit down with RSI for a second.
Here’s a picture of how RSI works:
Below the price of that picture that you see above, is the RSI indicator. Notice the words ‘overbought’ and ‘oversold’ on there? Good. Every time the line goes below ‘oversold’ (if it’s below “30”), the indicator is signaling that the crypto is oversold.
Every time the line goes above overbought (above “70”), it’s showing that it’s overbought.
The pink part is where the RSI is signaling oversold, and the blue is where it’s signaling ‘overbought’ ^
Simple enough, right?
Now, as I mentioned before, this is a momentum indicator.
What are those again?
Okay, from our chart we know that momentum indicators:
“Help identify the speed of price movement by comparing prices over time. It can also be used to analyze volume. It is calculated by comparing the current closing price to previous closing prices. Typically, this appears as a line below a price chart that oscillates as momentum changes. When there is a divergence between price and a momentum indicator, it can signal a change in future prices.”
I bolded those last few words in the sentence for a very good reason, but we’ll come back to that in just one second.
Next, let’s look at what a ‘leading’ indicator is. According to the chart that we posted above, “A leading indicator gives trades signals when the trend is about to start.” And, “They try to predict price, by using a shorter period in their calculation, thereby leading the price movement.”
So, you’re only going to use a leading momentum indicator like RSI when there is ALREADY A TREND IN PLACE.
I’m going to repeat that and break that down, because this concept is really important.
When. There. Is. Already a Trend in Place (CLEAR downtrend or UPTREND), then you will use RSI. The RSI will be used to determine WHEN THERE WILL BE A SHORT-TERM REVERSAL IN THE TREND.
Thus, it’s called a ‘leading indicator’, because it looks at when the trend will change.
Okay, now hold your horses, because this is where it gets a little bit confusing:
See that picture up above? That’s of Bitcoin. In that picture Bitcoin is in a DOWNtrend. Let me post another picture to emphasize this for you:
As you can see from the picture above, it’s an undeniable downtrend.
You’ll notice there are points within the downtrend where the price spikes up:
This is what fucks traders up the most and this is where a firm understanding of RSI is going to do you the most justice.
RSI is valuable in a clear downtrend like this for traders that are looking to catch those momentary rises.
How Do You Do That?
I’m going to show you. Let’s check out the RSI here (this is a 12H chart by the way):
So there’s the price at the top and the RSI indicator is at the bottom
At that very point where I drew that golden box, Bitcoin was still in its uptrend (notice how the RSI was hanging at the oversold point without trouble.
Now, if you’re a smart trader, you love it when there’s a cryptocurrency that’s in a CLEAR and DEFINED Uptrend with the RSI showing OVERsold levels.
Now, if someone was after the RSI levels, they would have been able to see the imminent dip at the top a mile away.
Let’s take a closer look:
You’ve probably heard this before. It’s called divergence. It’s VERY important to use and understand if you’re a trader that’s trying to expect changes in price direction.
Divergence is a fancy word that simply means that the RSI was going down, while the price was going up.
Yup, that’s it.
Okay, so let’s break this down.
The RSI is going DOWN while the price is going UP
Remember that the RSI is a momentum indicator. So, if the RSI is going down, that literally translates to “the momentum is decreasing”
Picture it this way:
Imagine someone is rolling a BIG boulder up a hill. That hill = price. The SPEED that the rock is being rolled up = RSI
When that person starts rolling that rock up from the bottom, they’re able to do it at a pretty decent speed. They’re well-rested, they ate a good meal, they stretched out, they’re prepared for this.
Now, as they continue to roll the rock up the hill, their muscles start getting TIRED.
Suddenly, you notice that their speed is slowing down. Anyone with common sense knows that he will only get more tired as he continues to try to push that rock up the hill.
Eventually, at some point, he’s going to have to take a rest and let that boulder go.
Now imagine you know all of this information that I just stated above. Your job is to predict when he’s going to let that boulder roll back down the hill. What’s the first thing you’d look at to make this prediction?
The SAME. EXACT. CONCEPT applies to RSI and price movement. If you see that RSI starting to fall back while the price is still rising, it is a hefty buy signal.
The RSI is a leading indicator, so if you catch this too late and the price is already down, you’re wasting your time using the RSI.
I’m going to repeat that again, if the price is ALREADY down and you’re using the RSI to confirm this, you’re NOT using it right and you’re making the mistake of thinking that you’re trading correctly.
Okay, Got It!
So What Can I Do In This Bear Market??
So, we covered how to use RSI in an uptrend (bull market), now let’s look at how to use in a BEAR market.
So, this is when Bitcoin reversed off of that $6k drop that it experienced in early February.
We can clearly see that the price reversed, but why? Was there any divergence?
No. Not on the 12 Hour Chart.
So what do we do now?
We try to see if we can detect if there was any divergence on lower chart time frames (TF).
There are a few things that should be accounted for here though:
1.) This was in a clear downtrend
2.) The RSI was signaling oversold
3.) The price was headed downward.
If all of those above conditions were not met, the effectiveness of the signal is nulled.
So, remember — here are the rules to using RSI to trade:
1.) Determine whether you’re in a bull market or bear market (if you don’t actually know the difference, you will get screwed so make sure you study how to make that determination).
2.) If you’re in a bull market the RSI is only an effective price PREDICTOR when the price of the coin is headed up.
3.) If you’re in a bear market the RSI is only an effective price PREDICTOR when the price of the coin is headed down.
4.) In the bull market the divergence is only a home run when the indicator reads overbought.
5.) In the bear market the divergence is only a home run when the indicator reads oversold.
6.) Simply assuming that “oversold=price will be going up soon!” will get you fucked up and lose you a lot of money.
7.) Simply assuming that “overbought=price will be going down soon!” will get you fucked up and lose you a lot of money.
Please note — there are times when the divergence can be found on a price run up in a bear market if the RSI is truly overbought and there is divergence. There are also times where divergence can be found in a bull market if the RSI is truly oversold and there is divergence.