Trading Class 101: Price Action Trading (Part 11) – Using RSI from Basic to Advanced

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2022-06-25 17:00:49

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Trading Class 101: Price Action Trading (Part 11) – Using RSI from Basic to Advanced

What is RSI?

RSI (Relative Strength Index) is a relative strength indicator that measures price changes.

Through the RSI, traders can determine the current price too buy (easily to be adjusted downwards in the near future) or too sold (easy to have a rally in the near future), thereby making more effective trading decisions.

Features of RSI

Calculation

The RSI is calculated by dividing the average price increase by the average price decrease over a certain period (cycle). Normally, you will rarely have to care about this because the TradingView or Binance charting tools both support automatic calculations.

Cycle

The default period of the RSI is 14, which means that the RSI value will be based on the closing price data of the previous 14 candles. This cycle may vary depending on your trading style. For example, cycle 25 will be calculated based on the closing price of the previous 25 candles… Normally, the default of RSI is always RSI (14).

RSI is expressed in the form line chart (line chart) with a range of 0 to 100. When the RSI oscillates up and approaches 100, the market is showing “overbought”. Conversely, when the RSI oscillates downwards and approaches zero, the market shows an “oversold”.

To make it easier to identify, traders often use additional 30 and 70 marks:

  • When RSI > 70: the market is overbought
  • When RSI < 30: the market is oversold

For example

In case the RSI is overbought and the price corrects down
Where the RSI is oversold and the price bounces up

However, you should note that identifying overbought and oversold is not the only factor for us to make a trading decision, because if you go against the trend, this is easy to be ineffective.

Example of an ineffective use case of RSI

You can see, although in the picture above, ETHUSDT chart 4H has continuously created RSI at < 25, but the price did not recover but dumped 40% more. So, if you buy in this case, you will lose.

In the next section, we will learn together how to use RSI effectively.

How to use basic RSI

If you only learn about RSI in a “superficial” way, it is easy to make mistakes like “short when RSI hits value > 70 because the market is overbought”or “long when RSI < 30 because the market is oversold”. This is not really correct.

I want to remind you of the most basic thing: Trend is friendand try to trade with the trend.

You can review the article about Trends and how to identify trends in the previous part.

Thus, if the main trend is an uptrend, now there are 2 cases:

  1. When the trend is strongly increasing, RSI > 70, you should patiently waiting price adjusted, because of the market there are signs too buy. If the price corrects will be a good opportunity to enter, on the contrary, if the price does not correct, we need to continue to wait. Don’t be in a hurry to go long when the price has risen sharply.
  2. When the main trend is up, you wait for the price to correct (small trend) and RSI < 30, then this is a very good opportunity to trade. buy up on the main trendbecause then the market showed signs of oversold in the small trend.

On the contrary, if the main trend of the market is downtrend, then there are 2 cases:

  1. When the trend is down strongly, RSI < 30, you should wait patiently for the retracement wave to have a better short entry, not short chasing or trying to catch falling knives.
  2. When the main trend is downtrend, you wait for the price to rise again (small trend) and RSI > 70, then this is a very good opportunity to trade. short in the main trend.

How to use advanced RSI with divergence/convergence

In addition to oscillating values, RSI has an extremely effective use of divergence/convergence. This is the use that allows you to catch effective bottoms and tops.

Divergence

  • Formed when price and RSI go “in opposite directions” and diverge in 2 directions, appearing at “top” areas.
  • Divergence can take place on many different time frames, when divergence occurs on large time frames it is more valuable (4H divergence is more valuable than 15 minute divergence); when divergences appear on many different timeframes (4H, 1H…), the higher the probability of winning.
  • Divergence can occur 2-3 spans.

For example

In the chart above, you can see:

ETH, after a strong rally, created the following highs higher than the previous peak, however, the RSI created the following highs lower than the previous peak. At that time, you can see that a top divergence has formed. Then the price corrected very strongly. In this case, the divergence occurs up to 3 spans.

Converging

  • Formed when price and RSI go against each other in the direction of convergence, usually appearing at the “bottom” areas.
  • Convergence can take place on many different timeframes, the higher the time frame the more effective, the more effective converging on multiple timeframes.
  • There may also be 2-3 beats.

For example

You can see, in the above example, the 4H ETH frame creates a lower bottom than the previous one, but the RSI creates a higher bottom than the previous one => convergence occurs, the price bounces up sharply. In this case, convergence occurs in 2 beats.

Note

To increase the probability of winning with this method, you should pay attention:

  • Follow the main trend. For example, if the 4H trend is up, the 1H frame is falling and converging bottoms => Long follows the 4h trend. Conversely, if the 4H trend is down, the 1H frame retraces and diverges => Short follow the 4H trend.
  • Combination of support and resistance. For example, the price creates a divergence at a strong resistance area => a sell order will have a higher probability of winning.

Thus, we have learned together how to use RSI from basic to advanced. Hope you can apply it successfully and reap profits in trading. See you guys in the next posts!

Poseidon

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