The combination of the RSI and Composite Index can create a powerful combination for detecting turns in cryptocurrency markets.

 

Combining the RSI and Composite Index

The Relative Strength Index is one of the most well-known tools in technical analysis. But like any field of study, original theories and ideas change. Tools become improved. The RSI is an excellent example of a tool that has well-known over the decades. As a bounded oscillator, the RSI only measures between 0 and 100. And people still use the default overbought and oversold levels that Welles Wilder developed in 1978. But beyond the standard overbought and oversold levels, the RSI is used extensively to detect a phenomenon known as divergences. Divergences are differences between price action and a corresponding oscillator. A bullish divergence occurs when price is creating lower lows, but the oscillator is forming higher lows. Bearish divergence occurs when price makes higher highs, but the oscillator makes lower highs. Observe the divergences below between Bitcoin’s price and the RSI.

Price and RSI divergences

Price and RSI divergences

At first glance, the chart above shows the RSI may be very effective at detercting possible changes in direction. But the RSI is limited to its base calculations – it does not measure for momentum. It sounds odd to say that a momentum indicator doesn’t measure its own momentum. That is where the Composite Index comes in. The Composite Index is a trademarked indicator created by one of the world’s best traders and technical analysis experts, Connie Brown. In a nutshell, the Composite Index is the RSI, but with a momentum measure of the RSI. As a result, the Composite Index will catch divergences that the RSI cannot. See below:

Composite Index Divergences

Composite Index Divergences

On Ethereum’s chart above, I’ve marked areas where the RSI and price show the same series of peaks and troughs with black arrows. In all of these instances, we can see that when price makes higher highs or lower lows, the RSI has followed price. But when we look below with the Composite Index, we can see that the Composite Index has spotted divergences that the RSI could not. So how does this help with trading? Simple. I only compare the RSI and the Composite Index, not price. If I spot a divergence, I then wait for the Composite Index line to cross one of its averages. Is it effective? The divergence and Composite Index crossover is not sufficient to form a signal. But if that divergence and Composite Index crossover occurs if price is near an important support or resistance level, then most definitely a signal could be generated.

Divergences

Divergences

The chart above shows divergence between the Composite Index and the RSI (with price). The thin black vertical lines represent when the Composite Index line crosses above or below its moving averages. These are not the only divergences that exist (hidden divergences are now shown), but just some. I would encourage you to go through your charts on your own particular time frame(s) to determine if this strategy would be of any use to your own trading.