Technical Analysis: How To Use The Relative Strength Index (RSI)

The RSI (Relative Strength Index) is a technical indicator. It’s used to confirm the momentum of price trends.

What is momentum?

The momentum is like the speedometer in a car.

It tells you how fast the car is moving.

But it doesn’t tell you which direction the car is moving.

That’s why you’ll want to combine the RSI with a different indicator, like the EMA.

• The EMA tells you the direction that the car is moving.
• The RSI tells you how fast the car is moving.

When you combine those two, you can predict where the car will be in 10 minutes.

Likewise, you can also use them to predict where the price will be in 10 minutes.

• If the EMA is bullish, and the RSI signals bullish momentum, the price is likely to keep going up.
• If the EMA is bearish, and the RSI signals bearish momentum, the price is likely to keep going down.

If the EMA is neither bullish or bearish, you are out of luck. You can’t use the RSI in that situation, because you don’t know the direction the price is moving. In other words, there is no trend.

RSI confirms or rejects a trend. Using it without a trend is like turning on your car engine, but not pressing the accelerator. Your car will go nowhere.

Ok, I have a trend. How do I use the RSI to confirm it?

Simple.

You use what is called an RSI divergence.

What is a divergence?

A divergence is when the price moves in one direction, but the RSI doesn’t follow.

Imagine that the price is your dog.

A divergence happens when you let the dog off its leash, and it runs into a neighbor’s garden.

If you don’t follow it all the way inside the garden, it’s a divergence.

The dog has reached a new location, but you didn’t follow.

Likewise, if the price reaches a new low, and the RSI doesn’t, it’s a divergence.

Let’s take a simple example:

• The price goes like this: 20,000 => 21,000 => 19,000
• The RSI goes like this: 40 => 50 => 45

Can you spot the divergence?

That’s right. The price reached a new low (19,000). But the RSI did not. That’s a divergence.

• If the price reaches a new low and the RSI does not, it’s a bullish divergence.
• If the price reaches a new high and the RSI does not, it’s a bearish divergence.

Alright, I know what an RSI divergence is — how do I use it?

Easy. If the price is trending up, you check if there is a bearish divergence. If there isn’t, the price is likely to continue trending up.

Opposite if the price is trending down.

Ok, but what about the value of the RSI? Isn’t that important as well?

Glad you asked.

The value of the RSI is also important.

When there is a bullish trend going on, the RSI tends to skyrocket. It sometimes go past 80.

An RSI above 80 is considered overbought. It’s likely that the bullish trend will stop soon — but you don’t know for sure. The RSI could keep going up till it reaches 100.

Ok, so what should I do if its above 80?

Be calm and look for any signs of reversal.

If the RSI crosses above 80, it’s a sign that you need to be extra careful.

The bullish trend could end very soon, and turn into a bearish trend.

If the RSI crosses above 80, and then crosses below 80, it’s a strong signal that the bullish trend is about to end.

We call this event a bearish crossover.

If you have both a bearish crossover and a bearish divergence, at the same time, it’s a strong sign that you need to exit your long position. Abandon ship!

Alright, I’ll look out for those crossovers. And be extra careful when it’s above 80. Anything else?

Yes. Make sure you profit from the reversal.

Open a short position when you see the ship sinking.

That’s it.

TL;DR

Use the RSI to confirm trend momentum.

You will need another indicator, like the EMA, to confirm the trend direction.

Look out for divergences and crossovers. If both happen at the same time, the trend is likely to reverse. If none of them happen, the trend could continue.