Technical analysis, the study of chart patterns, is a tool that helps traders increase their lead over others.

It does this by keeping the trader on the right side of the trend and issuing warnings if the trend is reversing. There are many indicators and patterns that can do this job, but there is no one particular indicator that will work for all market conditions.

Hence, traders prefer a combination of indicators that are useful in both trending and area-based markets. However, this does not mean that the trader should clutter every chart with all available indicators. In some cases, using too many indicators will only hinder the decision-making process and create confusion rather than helping the trader.

As traders develop their chart reading skills, they tend to reduce the number of indicators and use those that are more appropriate for their trading style. Again, there is no perfect set of indicators that will give better results than others, it’s just a matter of preference and practice.

In this article, the moving averages and the relative strength index are discussed as indicators. Without going too deeply into the technical details of each indicator, it outlines the basic ways to use them effectively. The methods discussed here are by no means exhaustive, there are countless other options and traders can use whichever is best for them. The explanation can be used as a guide for further refinement of analytical skills.

Moving averages

Moving averages are trend-following or lagging indicators as they provide delayed feedback after the price movement has already taken place. The most popular time frames used for trading and investing are the 20, 50 and 200 period moving averages. Short term traders also use the 5 and 10 period moving averages, but they tend to slip and may not be suitable for everyone.

There are four types of moving averages: simple, exponential, smoothed, and weighted, but the most commonly used are the simple and exponential moving averages.

When calculating, exponential moving averages give more weight to recent price data, so they tend to react quickly to price changes. On the other hand, a simple moving average gives price data the same weight, so they tend to react comparatively slowly to price changes.

Hence, traders tend to use EMA for the shorter time frames like 10 and 20 as they capture the changes quickly and for the longer time frame the simple moving averages are used as trends usually don’t change direction quickly. The current example uses the 20-day EMA and the 50-day SMA.

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum indicator that tracks price changes and acts as an oscillator that ranges between values ​​from 0 to 100.

As a rule, values ​​below 30 are referred to as oversold and above 70 as overbought. While these boundaries work well during a sectoral market, they tend to give the wrong signal during trending phases.

The most common time frame used is a 14 period RSI. This is not set in stone, however, as short-term traders can use a 5 or 7-period RSI, while long-term investors can opt for a 21 or even 30-period RSI.

One of the most popular uses for the RSI is to detect divergence, which warns traders of a possible trend reversal. After the basics, let’s look at some methods of using the indicators for analysis.

The first thing a trader should learn is to spot a trend. Trading in the direction of the trend is worthwhile as an established trend offers several profitable trades. Let’s understand this with some crypto price promotions.

Examples of a sector-specific market

BTC / USDT daily chart. Source: TradingView

In a sector-bound market, the moving averages cross and do not slope up or down over a long period of time. Look at the area enclosed by the ellipse in the graph above where Bitcoin (BTC) stayed in the range and the moving averages have flattened out. Such markets tend to be directionless and difficult to forecast and trade.

DOT / USDT daily chart. Source: TradingView

As shown in the graph above, the price of Polkadot (DOT) was stuck in a range and the moving averages were flat with no sense of direction. When the price is broadly between two boundaries, the market is said to be sectoral.

Next we try to identify a trending market, because this is where the most lucrative trading opportunities arise.

Recognize an upward trend

BTC / USDT daily chart. Source: TradingView

Bitcoin was largely stuck in a range from August 1, 2020 to October 20, 2020. During this time the moving averages were flat and directionless.

However, on October 21, 2020, the price broke above the range and the RSI also jumped into the overbought territory. At the start of a new trend, the RSI generally remains overbought in the early stages of the trend, and the same was seen here.

As the price rose, the 20-day EMA began to rise first, and then the 50-day SMA followed. When a trend starts, it usually stays in place for an extended period of time. Let’s look at another example of a trend.

DOT / USDT daily chart. Source: TradingView

After the DOT remained in a range from September 6, 2020 to December 27, 2020, the DOT broke out of the range on December 28, 2020. The RSI also rose to overbought levels above 70 and the moving averages began to move higher. Again, notice how the 20-day EMA moved up quickly while the 50-day SMA took time to catch up.

In the above case, the RSI did not stay overbought for an extended period of time, but stayed above 50, which suggests that a rule does not fit everywhere.

Recognize a downward trend

Unlike uptrends, which take time to form and stay in place for an extended period of time, downtrends are violent and can either stretch for a long time, similar to the 2018 crypto bear market, or quickly after a sharp decline Reverse direction.

BTC / USDT daily chart. Source: TradingView

The above chart contains two important things that the trader should be aware of. First, the RSI had hit lower highs since late February, even though the price had continued to rise. This is a classic sign of a possible turnaround. Again, this is not foolproof, but when traders combine the signal with the price action then the chance of avoiding disaster is high.

The negative divergence on the RSI gained momentum as the moving averages made a bearish crossover as the 20-day EMA, which had stayed above the 50-day SMA for the past few months, fell below the 50-day SMA . This was a sign that short-term price action was weakening and the trend may reverse.

After staying in a range for a few days, Bitcoin collapsed on May 12 and the moving averages began to go down. This, along with the RSI in negative territory, signaled to traders that the trend was reversing. As long as the price stays below the moving averages and both the 20-day EMA and 50-day SMA continue to trend lower, the trend will remain bearish.

DOT / USDT daily chart. Source: TradingView

In the graph above we can see that after the uptrend, the DOT was stuck in a range where the moving averages were flattening and crisscrossing. Difficult to call this the top as the price could have gone either way. However, when the trader also looked at the RSI, he showed a negative divergence and warned of a possible reversal.

The sharp fall on May 19th confirmed the downtrend as both moving averages started falling and the RSI is in negative territory.

Remember, no signal is absolute!

For most new traders, the moving averages and RSI are essentially the starting point for identifying trends.

Tip-toe investors should definitely practice identifying the main trend as this could prevent them from going against the market and getting burned. In the following articles, entry and exit strategies are discussed using the indicators.

The views and opinions expressed are those of the author only and do not necessarily reflect the views of Cointelegraph.com. Every step of investing and trading involves risk, so you should do your own research when making a decision.

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