RSI and momentum

A moving average shows the direction. Momentum indicators ask something else: how strong is the move? The best known of them is RSI (Relative Strength Index), introduced by J. Welles Wilder in 1978.

What RSI measures#

RSI compares the average rises and the average falls over the last 14 periods and converts the result to a scale of 0 to 100:

• around 50 – rises and falls are balanced,
• above 70 – rises clearly dominate, the market is so-called overbought,
• below 30 – falls dominate, the market is oversold.

It sounds simple: sell above 70, buy below 30. And that is exactly the most expensive beginner's mistake.

Overbought does not mean sell#

Look at Bitcoin in autumn 2020. From mid-October to 25 November RSI was above 70 – almost six weeks in a row. Anyone selling "because the market is overbought" sold at 11,500, at 13,000, at 15,000… The price meanwhile rose from 11,503 to 18,719. And a month later it was above 24,000.

A high RSI in a strong trend does not mean the move is ending. It means it is strong. An overbought market can become even more overbought.

How to use RSI sensibly#

• As a strength thermometer, not a trigger. RSI above 50 and rising confirms that buyers are in control.
• It works better in a range than in a trend. When the price stays between support and resistance, RSI near the edges of the range can help with timing. In a strong trend it will mislead you.
• Divergence as a warning. When the price makes a new high but RSI does not, the move is losing strength. Such a warning can take weeks to play out, though – and may never play out at all.

Common myths#

• "RSI 80 – it has to fall." In January 2021 Bitcoin's RSI was around 90 and the price was above 40,000.
• "RSI below 30 is a sure buy." In a crash it can stay below 30 as long as above 70 in a rally.
• "I will change the setting to 7 and it will be more accurate." It will be faster – and with more false signals.