Top Three Technical Indicators For Crypto Trading - Reading time: about 6 minutes
For all the information that a crypto trading chart presents, traders often need to delve a little deeper to make sense of the price data. Hidden in the many data points on a typical chart are patterns that can help traders to make predictions about future trends. To identify these patterns, traders use tools known as technical indicators. In this article, we’ll explain what technical indicators are, why they are a key part of a crypto trader’s arsenal, and the most commonly used technical indicators.
What are technical indicators?
Technical indicators are essentially complex calculations that use existing trading data such as price and volume to chart predictions about the direction that a token might take.
Technical indicators generally fall into one of two categories: leading or lagging indicators. Leading indicators cast forward to provide predictions around price action and what might happen in the future. Lagging indicators typically focus on historical data to confirm price movements that have happened in the past.
Why are technical indicators important in crypto trading?
Technical indicators help traders to identify price trends as well as support and resistance levels. A successful crypto trading strategy might incorporate various technical indicators to anticipate potential opportunities, as well as optimal entry and exit points. These calculations can significantly increase a crypto trader’s chances of success in the markets.
It should be noted that using technical indicators and technical analysis is a separate discipline from fundamental analysis, which instead looks at external economic and financial influences on a token’s price.
Most commonly used technical indicators
Here are three of the most common technical indicators and how they can be used to supercharge crypto trading.
1. Moving Averages (MA)
A moving average helps smooth out price action by calculating the average token price over a specified period. This indicator is plotted on the trading chart as a line and comes in different variations, such as simple moving averages (SMAs), exponential moving averages (EMAs), and weighted moving averages (WMAs).
Simple moving averages are calculated by taking the sum of the closing prices of a token over a specific time period and then dividing it by that time period. For example, to calculate a 50-day SMA would add up the closing prices of the token for the past 50 days and then divide the sum by 50. The 50-day and 200-day are the most typical time periods used for the moving average. Crypto day traders might find the 20-day moving average more useful for analyzing price movement over the short term.
Exponential moving averages give more weight to recent prices, hence are more responsive to current price action. In other words, they are calculated using a formula that places a greater weight on the most recent prices.
Similar to EMAs, weighted moving averages place a greater weight on the most recent prices using a weighting specified by the user unlike EMAs, that use a specific formula.
Moving averages are often used as a lagging indicator, as they provide results based on price movements that have already taken place. If a moving average is trending upwards, the token’s price movement can be classified as bullish, and downward-trending as bearish.
2. Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a technical indicator which can be used to show if a token is overbought or oversold. Devised by Welles Wilder in 1978, this indicator is calculated using the average gains and losses of a token over a specified number of periods. It is plotted on a scale from 0 to 100.
RSI is calculated by first averaging the gain and loss over the specified number of periods. The average gain is calculated by taking the sum of the gains over the number of periods, and dividing that sum by the number of periods. The average loss is calculated in a similar manner with the sum of the losses divided by the number of periods. The RSI is then calculated using the following formula:
RSI = 100 - (100 / (1 + (average gain / average loss)))
The RSI is considered overbought when it is above 70 and oversold when it is below 30. These levels can be adjusted based on the particular token or market being analyzed. Most crypto traders use the RSI over a 14-day period.
The RSI can be used to identify potential trend reversals, as well as to confirm the strength of a trend. It can also be used in combination with other technical indicators to generate buy and sell signals.
3. Bollinger Bands
Bollinger Bands consist of a set of three lines plotted on a chart. Named after John Bollinger, these three lines comprise the simple moving average (SMA) combined with standard deviations to indicate volatility.
The middle line is a SMA of the security’s price, while the upper and lower bands are plotted at a certain number of standard deviations above and below the SMA. The standard deviation is a measure of volatility and the bands are used to help identify periods of high and low volatility.
Bollinger Bands are plotted on a chart using the following formula:
Upper band = SMA + (number of standard deviations x standard deviation)
Lower band = SMA - (number of standard deviations x standard deviation)
Points on the graph where the bands contract indicate low current volatility with the likelihood of high volatility in the near future, potentially signalling a breakout in price action. These movements are known as Bollinger’s ‘squeeze’ and ‘bounce.’
Other useful buy and sell signals come in the form of prices touching the upper and lower bands. If the closing price touches the lower band, it is generally considered a buy signal, while a closing price touching the upper band should be taken as a sell signal.
The default setting for Bollinger Bands is a 20-period SMA with the upper and lower bands plotted at two standard deviations above and below the SMA. However, these parameters can be adjusted based on the token being analyzed.
Trading technical indicators are important because they provide traders with valuable information about the current market conditions and potential future price movements. While the world of technical analysis might seem intimidating at first, knowing what a technical indicator is and how to use the three indicators discussed in this article will give you a leg up in your crypto trading.