Crypto Academy season 2 week 4 - Homework Post for @kouba01| Cryptocurrency Trading with RSI

Relative strength index, RSI for short is a technical indicator used in the analysis of financial markets . it's categorised under momentum indicators and best measures the rate of change (rise or fall) of a financial instrument or commodity to determine market conditions (oversold or overbought).

The relative strength index is calculated with a two-part formula
RSI = 100 − [ 100 / 1 +(Average gain / Average loss]
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In the above mathematical concept. The term average is key here. It simply means the total value of a certain period (in the case of trading) divided by the number of Integers. It's the same with your understanding of the arithmetic mean.

Based on the computation formula, the RSI would rise when the number of positive closes increase and conversely fall when otherwise.
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Can we trust the RSI on cryptocurrency trading and why?

In cryptocurrency trading or any type of trading in general, It's not advisable to rely solely on the information given by one indicator. Even in the area of trust, the RSI indicator wouldn't always do so well why?

The reason being that the RSI indicator is a momentum indicator and momentum indicators are dependent indicators hence they work best when paired with other forms of indicators since they don't disclose the potential direction of the instrument.

Also, most inexperienced traders are of the general belief that "according to this indicator buy when the market is oversold and sell when it's overbought". While this may prove helpful, in some scenarios it isn't always like this.

There are instances when the market remains in a trend (uptrend or downtrend) and this would make the indicator remains in overbought or oversold regions for a number of periods. Hence one shouldn't be entirely dependent on the RSI indicator.

How do you configure the RSI indicator on the chart and what does the length parameter mean?

To configure the RSI indicator to your charts all you have to do is (assuming you're using trading view) navigate to indicators in the top section.

• navigate to built-ins

• search for the relative strength index or just RSI and click on it.
  

  
  
  

• The indicator would be configured to charts with its default settings.

The length parameter on the RSI indicator indicates trading periods.

Why is it equal to 14 by default? Can we change it?

By default, the RSI indicator displays a default value of length period 14 and the time frame selected plays a major role in how the RSI interprets the market. In tackling the question about length above I mentioned the term periods (default 1length of 14 on RSI). However periods here don't signify a constant i.e if the default length 14 is used and the time frame is set at an hourly frame, only the price change for the last 14 hours would be taken into consideration, similarly, if the timeframe is a daily timeframe. The periods taken into consideration will span the last 14 days

although it's entirely possible to change or customize your indicator settings including the RSI indicator. To do this, navigate to the indicator header (hover your cursor around the indicator name) this would open a tab with customization settings.

• Click settings, a tab would automatically open up.
• Navigate to the inputs panel. Here lie the customization settings for the length parameter.
  
  
  
• Adjust the length parameter to your desired number.
  It can be changed to suit your trade style. Swing or daily traders would find the default 14 to be quite ok but long-term traders might want to increase the time period.

How do you interpret the overbought and oversold signals when trading cryptocurrencies?

The graph of the RSI is divided into three regions or zones and each major zone represents a position. With the aid of a chart diagram ill tender my explanation

the price normally moves through the zones represented by 70 and 30 and when price remains in this zone it indicates a neutral condition however when price crosses above the upper limit which is represented by 70. It indicates an overbought market.

Overbought is a condition used to imply that the price of a financial instrument went too far up than expected hence a pullback of price is anticipated. It usually occurs when price crossed over the 70 range.

Conversely, when price crosses below the lower zone represented by 30. It indicates an oversold position which means the price of a financial instrument dropped too far down and hence a price bounce is expected.

How do we filter RSI signals to distinguish and recognize true signals from false signals

There are ways to filter out false signals from the RSI indicator. As depicted before no indicator would give you 100% accurate signals all the time. There are cases of divergence (bullish and bearish) in the case of using the RSI indicator.

A bullish divergence occurs when a series of lower low patterns occurs on a chart giving rise to a bulish pattern but the RSI indicator would often maintain a higher low pattern as depicted in the image below.

_{a chart depicting a bullish divergence with the use of the RSI indicator}
source
A bearish divergence is the slight opposite. It occurs when the price of an asset keeps rising developing a series of higher low patterns but a look at the indicator would show it display a lower low pattern.


_{a chart depicting a bearish divergence with the use of the RSI indicator}
Source

Another thing to also note is that the shorter the time period on the RSI indicator the erroneous the movement of the RSI would be as it would continually switch from overbought to oversold zones. Sometimes increasing the time period or length from the default to a longer timeframe provides better signals

Secondly, as the RSI indicator is an oscillator or momentum indicator it should never be used alone. Pairing it with other indicators like the simple moving average or MACD oscillator seems to do the trick sometimes.

Review the chart of any pair (eg TRX / USD) and present the various signals from the RSI.

Below is the chart of the pair (TRX / USD), taken from trading view

I've tried to mark the more accurate RSI signals. When we examine the situations where the market becomes overbought. You need no further confirmation if due attention is paid to the candlestick formation. There was a strong buying pressure at first which pushed price all the way up but soon after the sellers began to overpower the buyers. This could be noticed through the higher upper wick of the candle closes and further confirmed by the overbought RSI signal. There are also instances when the market moved in an oversold position dipping below the 30 hallmark however the trend doesn't last long. this is more beneficial for swing traders to lock in profits.