There are a wide variety of trading types that you can try. Whether you choose to participate in Forex trading, commodities trading, or share trading, technical analysis is quite useful. It is an ideal discipline to have in your strategy, and this includes studying an array of technical indicators.
Indicators are technical analysis tools that base their information on mathematics. Traders and investors typically use them to analyze price patterns and trends from the past. Doing so will give them the information they need to anticipate future price trends and patterns. Fundamental analysis usually tracks economic data, annual reports, or various other measures pertaining to corporate profitability. Technical traders, on the other hand, rely primarily on charts and indicators to help with the interpretation of price moves.
The main intention when it comes to using indicators is to properly identify trading opportunities. Let’s use a moving average as an example. A crossover of this kind is often indicative of an upcoming trend change. In this particular instance, applying the moving average indicator to a price chart allows traders to determine where exactly the trend may run out of steam. What’s more, it shows where it may change direction, which in turn effectively creates a trading opportunity.
Strategies frequently utilize technical indicators in a manner that is completely objective. With it, they can pinpoint entry, exit, and/or trade management rules. A strategy specifies the exact conditions that traders are established under (aka. setups). This also connects to the adjustments and closure of positions. Oftentimes, strategies include the intricate use of indicators – sometimes multiple indicators – to establish when trading activity will occur.
But what are the best indicators to use in relation to crypto?
Overview of technical analysis
Let’s first provide context as to what this type of analysis is. ‘Technical analysis’ is a trading discipline that helps with the evaluation of investments and identification of trading opportunities. This is possible by way of analyzing statistical trends deriving from trading activity, which includes price movement and volume.
There is a noticeable difference between this brand of analysis and fundamental analysis, as briefly touched upon earlier. Fundamental analysis aims to gauge a security’s value by drawing from business results. Examples of this include sales and earnings. Meanwhile, the technical analysis puts all of its focuses on the study of both price and volume. Technical analysis tools are useful for dissecting how supply and demand for a security will affect any changes. Specifically, changes in volume, price, and implicit volatility.
Technical analysis is a popular method of generating short-term trading signals from various charting tools. Beyond that, though, it can help improve the evaluation of a security’s strength or weakness in connection to the broader market. Alternatively, just one of its sectors. This information is vital for analysts looking to improve their overall valuation estimate.
This type of analysis operates from the belief that previous trading activity and price changes of a security are valuable. Particularly as indicators that determine the security’s future price movements when you pair it with the right investing or trading rules. Professional analysts typically use technical analysis together with other different forms of research.
Retail traders often make decisions by drawing from the price charts of a security and similar statistics. However, practicing equity analysts don’t limit their research to fundamental or technical analysis alone.
The three trends
In total, there are three possible trends:
- Uptrend: In the case of an uptrend, the asset is going up, making higher highs and higher lows.
- Downtrend: In the case of a downtrend, the asset is going down, making lower highs and lower lows.
- Sideways trend: In the case of a sideways trend, the asset is trading in a horizontal channel
There are times when traders also use the popular terms “bearish” and “bullish.” More often than not, they use them to refer to a trend. Bullish comes from the word “bull,” which is an animal that strikes upwards with its horns. Therefore, it pushes prices higher. Bearish comes from the word “bear,” which is an animal that strikes downward with its paws. In this sense, it is driving prices down.
Introduction to indicators
‘Technical indicators’ are heuristic or mathematical calculations. They base their calculations on the price, volume, or open interest of either a security or contract. Specifically, those that traders who follow technical analysis commonly use. By closely examining historical data, technical analysts can utilize indicators as a way to predict future movements in price.
Traders will often use technical indicators to help them determine an asset’s long-term and short-term price direction. With these tools, they are able to measure anything from momentum, volume, and quality of price movement, among other things. These indicators are mathematical calculations – or ‘signals’ – that are common in technical analysis. They detect what may occur with the price of a security, commodity, stock, or currency. Or, in the case of this article, cryptocurrency.
There is an increasing number of technical indicators that are available for traders to study. With the inclusion of those in the public domain, examples are a moving average or the stochastic oscillator. Moreover, there are commercially available proprietary indicators.
In addition, a majority of traders will sometimes develop their own unique indicators. Oftentimes, they will do so with the assistance of a programmer with admirable experience. A bulk of indicators have variables that users are able to define. This allows traders to adapt key inputs in order to suit their needs. An example of this is the ‘look-back period’, which is how much historical data will help form the calculations.
There are two basic types of technical indicators: overlays and oscillators.
- Overlays are technical indicators that use the same scale as prices are plotted over the prices present on a stock chart. Two noteworthy examples of this indicator include moving averages and Bollinger Bands.
- Oscillators are technical indicators that oscillate between a local minimum and maximum. They are plotted either above or below a price chart. Some examples of this indicator include the stochastic oscillator, MACD, or RSI.
Traders typically use an array of diverse technical indicators when they are analyzing a security. There are thousands of different options, so of course, traders must choose the indicators that work best for them. From there, they need to familiarize themselves with how they operate.
There are times when traders may combine technical indicators with more subjective forms of technical analysis. They do this in the fop that they can come up with other trade ideas. An example of another form of technical analysis that they combine with indicators is looking at chart patterns. It is also possible to incorporate technical indicators into automated trading systems. This makes sense when you take their quantitative nature into consideration.
A strategy is a set of objective, absolute rules that define when exactly a trader is going to take action. A strategy that is too basic (ex. buying when the price moves above the moving average) is usually not feasible. This is mostly because a simple rule runs the risk of being too evasive. Moreover, it does not provide any precise details for taking action.
Below are some examples of questions that you need to answer in order to create an objective strategy:
- What type of moving average will you use? (this includes length and price point for the calculation)
- How far above the moving average will the price need to move?
- Should you enter the trade as soon as the price moves a specific distance above the moving average? Or at the close of the bar? Or at the open of the next bar?
- What type of order will you use to place the trade? Limit or market?
- How many contracts or shares will you be trading?
- What are the rules pertaining to money management?
- What are the exit rules?
So, what technical indicators should I use?
While there are a wide variety of technical indicators to choose from, there are some that are more applicable to cryptocurrency than others. There are six noteworthy ones that we will go over. They are Relative Strength Index, Stochastics Oscillator, Moving Average Convergence Divergence, Average Directional Index, Aroon Oscillator, and On Balance Volume.
Interested in charting indicators? Check out: What is a Schaff Trend Cycle?
1 – Relative Strength Index (RSI)
Relative Strength Index helps with the quantification of an asset’s gains and losses over a certain period of time. This is among the more popular and recognizable indicators within the crypto trading community. It is a tool that both beginners and expert traders can use.
The conventional RSI ranges from 0 to 100 and helps you determine if an instrument is overbought or oversold. Let’s assume that an asset’s RSI is ticking at around 70. In this particular instance, it is overbought. Anything that falls below 30 means it is oversold.
In addition, it will provide assistance for determining if your cryptocurrency is within a bullish or bearish phase. Anything that falls below 50 is bearish and, as you can no doubt guess, anything going above 50 is bullish. If the movement is prone to fluctuating between 0–50 for an excessive amount of time, it’s in a bearish cycle. However, if the movement has a tendency to fluctuate between 50–100, then it’s in a bullish cycle.
An overbought signal is indicative of the short-term gains potentially reaching a point of maturity. Furthermore, there may be a price correction on the horizon for assets. Contrarily, an oversold signal may signify that short-term declines are reaching maturity. What’s more, there could be a rally in store for assets.
2 – Stochastic Oscillator
The Stochastic Oscillator is a two-line momentum indicator that crypto traders frequently use as a measuring tool. It is useful for assessing the difference between the closing price and the range of prices over a specific period of time. The Stochastics Oscillator will often utilize the prices of the previous 14 days in order to properly determine a score.
A score that ranks above 80 means that the asset is overbought, whereas a score below 20 means it’s oversold. If, however, a strong trend is present, then a correction or rally will in all likelihood not ensue. Overall, the scale of the Stochastic Oscillator operates on a scale of 0 to 100; similar to the RSI.
The %K and %D are the two definitive lines that exist in this chart. The %K line keeps track of the asset’s momentum. %D, on the other hand, keeps track of a three-day simple moving average of %K. The indications of the best buy and sell times typically derive from the %K line cutting over or under the %D line.
3 – Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence is another famous indicator that traders frequently use. “Convergence” means that two moving averages are joining together. “Divergence,” as one might expect, means that they are moving away from each other. In the event of moving averages converging, it indicates a decline in momentum. If the moving averages are diverging, though, that indicates an increase in momentum.
By using this signal, you can predict the start of a short-term price trend. Moreover, you can forecast any potential reversals of a security. If you want to calculate the MACD, you will need to do a little subtracting. Specifically, a cryptocurrency’s 26-day exponential moving average (EMA) from the 12-day EMA.
Many see the MACD signal to be a positive factor when the 12-day EMA is above the 26-day EMA. This is indicative of momentum experiencing a substantial rise. In other words, signifying that it is time to buy. When the longer-term moving average ranks above the short term average, you may want to sell due to the momentum moving downward.
Beyond the MACD, there are some traders who also track the ‘signal’ line. This is a 9-day EMA that aids in the identification of the buy/sell calls. When the signal line is breached in an upward move, this signifies a bullish run. An MACD that is running below the signal typically indicates a bearish movement.
4 – Average Directional Index
This indicator is useful when it comes to detecting the quality of a price movement. The ADI possesses a score range going from 0 to 100 and many consider it to be a non-directional signal. To elaborate, it does not present a specific direction pertaining to the price movement. It helps with the determination of an upward or downward momentum’s strength.
If the ADI’s reading exceeds 25, traders see that as a time to implement trend-trading strategies. A score falling below 25, however, is indicative of the opposite.
Here is a breakdown of ADX reading strength:
- 0-25 No Trend
- 25-50 Weak Trend
- 50-75 Medium Trend
- 75-100 Strong Trend
5 – Aroon Oscillator
The scale of this indicator is set from -100 to 100. It’s useful for predicting the time in which the momentum of a security will change direction. Cryptocurrency traders are of the belief that the Aroon Oscillator is a versatile tool. There is some merit to this because it signals both the direction and the strength of the price movement.
A score that ranks above 0 suggests upward momentum. The identification of the strength of the signal is often by the value of the AO reading. A security possessing an AO value of 10, for example, is considerably weaker in comparison to that of another security 50. They are both in a positive upward trend.
Following those same lines, any score that falls below 0 suggests a negative trend; in other words, downward momentum. An alteration in the direction of the AO indicators is a tell-tale hint of a reversal in the price direction.
6 – On Balance Volume (OBV)
Traders use On-Balance Volume as a way to forecast the price of an asset. They draw their information from the change in the transaction volume. OBV is a cumulative indicator that doubles as a running total of both positive and negative volumes.
The primary premise here is that any dramatic shift in volume suggests a potential change in asset price. If the volume should rise at a steady pace with no change in price, then the OBV indicator will rise. What’s more, it will predict the occurrence of a price increase in the near future. If OBV is declining while the price retains its steady pace, then it implies an asset’s upcoming price fall.
Learn more about technical indicators in our article: What is an Aroon Indicator?