Technical analysis, the study of chart patterns, is a tool that helps traders increase their lead over others.
This is done by placing the trader to the right of the trend and providing warnings when the trend is reversed. There are many indicators and patterns that can accomplish this task but there is no single specific indicator that fits the bill for all market conditions.
Therefore, traders prefer to use a combination of indicators that are useful during both trending and range-bound markets. However, this does not mean that the trader should clutter every chart with all available indicators. In some cases, using too many indicators only hinders the decision-making process and creates confusion rather than helping the trader.
As traders develop their chart reading skills, they reduce the number of indicators and use indicators that are compatible with their style of trading. Here again, there is no correct set of indicators that will give better results than others, it is just a matter of preference and practice.
In this article, the indicators that will be discussed are the moving average and relative strength index. Without going too deep into the technicalities of each indicator, basic methods of using them effectively will be highlighted. The methods discussed here are by no means exhaustive, there are innumerable other possibilities and traders can use those that work best for them. Explanation can be used as a guide to further improve analysis skills.
Moving averages are also called trend-following or lagging indicators because they provide delayed feedback well in advance of the price movement. The most popular timeframes used for trade and investment are 20, 50 and 200-period moving averages. Short-term traders also use 5 and 10-period moving averages, but they remain cautious and may not be suitable for everyone.
There are four types of moving averages: simple, exponential, smooth, and weighted, but the most popular are simple and exponential moving averages in use.
For calculations, exponential moving averages tend to overestimate recent price data, so they respond quickly to price changes. On the other hand, a simple moving average gives equal importance to price data, so they are comparatively slow in response to price changes.
Therefore, traders use EMAs for shorter timeframes, such as 10 and 20 because they capture changes quickly and for longer time frames, simple moving averages are used because trends typically tend to move quickly. Do not change. For the current example, 20-day EMAs and 50-day SMAs will be used.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a momentum indicator that captures a change in value and acts as an oscillator that ranges from a value of 0 to 100.
As a general practice, readings below 30 are called oversold, and readings above 70 are considered overbought. While these limits work well during a range bound market, they give incorrect signals during the trending stages.
The most popular time frame used is the 14-period RSI. However, it is not set in stone as short-term traders can use 5 or 7-period RSIs while long-term investors can opt for 21- or 30-term RSIs.
One of the most popular uses for RSI is deviation detection, which warns traders to reverse potential trends. After the basics, let’s look at some ways to use indicators for analysis.
The first thing a trader should learn is to find the trend. Trading in the direction of the trend is beneficial because an established trend provides many profitable trades. Let us understand this with some crypto price action.
Examples of a bounded market
In a bordering market, the moving average crosses each other and does not slope up or down for extended periods. Look at the area surrounded by ellipses in the chart above where bitcoin (B T c) Remained range bound and the moving average fell flat. Such markets lack direction and are difficult to forecast and trade.
As shown in the chart above, Polkadot’s (Telecom Deptt) The price was stuck in a range and the moving average was flat without any direction. When the price is largely contained between the two limits, the market is said to be bounded.
Next, let’s try to explore a trending market because this is where the most lucrative business opportunities arise.
Identifying an uptrend
Bitcoin was largely stuck in the range from August 1, 2020 to October 20, 2020. During this period, the moving average was flat and without any direction.
However, on October 21, 2020, the price broke above the threshold and the RSI also jumped into the overbought zone. During the beginning of a new trend, the RSI is generally overbought for the initial period of the trend and can also be seen here.
As the price went up, the 20-day EMA first started rising and then the 50-day SMA followed suit. When a trend begins, it usually remains in force for an extended period. Let’s look at another example of a trend.
After being in the range from September 6, 2020 to December 27, 2020, the DOT went out of range on December 28, 2020. The RSI also reached a level above 70 and the moving average slope started. Again, notice how the 20-day EMA progressed rapidly while the 50-day SMA took time to catch up.
In the above case, the RSI did not remain overbought for an extended period, but remained above 50, indicating that a rule does not fit everywhere.
Identifying a downtrend
Unlike uptrends, which take time to form and remain in force for an extended period, downtrends are violent and can either be prolonged, similar to the 2018 crypto bear market, or quickly change direction after a sharp decline Can be reversed.
There are two important things to be noted for the trader in the above chart. First, the RSI had remained a low top since the end of February, even as the price continued to rise. This is a classic sign of a possible trend reversal. Again, this is not fullproof, but if traders combine the signal with the price action, it is more likely to avoid catastrophe.
The negative divergence on the RSI became significant when the moving average completed a bearish crossover, where the 20-day EMA, which had been staying above the 50-day SMA for the past few months, broke below the 50-day SMA. This was an indication that short-term price action was weakening and the trend could reverse.
After being in a radius for a few days, on May 12, bitcoin broke and the moving average started going down. This was an indication for traders with RSI in negative territory that the trend was reversing. As long as prices remain below the moving average and both 20-day EMAs and 50-day SMAs tend to be downward, the trend will remain bearish.
In the chart above we can see that after the uptrend, the DOT got stuck in a range, with the moving average leveling each other and crossing each other. It is difficult to call it top because the price could have gone either way. However, if the trader also looked at the RSI, it was showing a negative deviation, warning of a possible reversal.
The sharp fall on May 19 confirmed the downtrend as both moving averages started going down and the RSI is in negative territory.
Remember, no signal is complete!
For most new traders, moving averages and RSI are essentially the starting point for identifying trends.
Investors dipping their toes into the business should definitely practice identifying the main trend as it can save them from going against the market and burning. Entry and exit strategies using indicators will be discussed in later articles.
The views and opinions expressed herein are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and business move involves risk, you must do your own research when making decisions.