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 in the correct direction 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 single indicator for all market conditions.

Hence, traders like to combine indicators that come in handy in both trending and sectoral markets. However, this does not mean that traders should clutter the chart with all available indicators. In some cases, using too many indicators will only hinder decision making and create confusion rather than aid trading.

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

This article discusses the Moving Average (MA) and Relative Strength Index (RSI). Without delving too deep into the techniques of each indicator, it will outline basic ways to use them effectively. The methods discussed here are by no means perfect, there are myriad other options and traders can use those that work best for them. The explanation can be used as a guide to further refine analytical skills.

Moving average

Moving averages are also known as lagging indicators because they only react after a price movement has occurred. The most popular frameworks 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 be deceptive 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 simple moving averages (SMA) and exponential moving averages (EMAs).

When doing calculations, exponential moving averages give price data more weight, so it tends to react quickly to price changes. The simple moving average, on the other hand, weights price data equally, i.e. reacts relatively slowly to price changes.

Hence, traders tend to use EMAs for shorter frames like 10 and 20 when they are capturing rapid changes, and SMA lines are used for longer time frames because they don’t change direction when the trend changes rapidly. 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 between 0 and 100.

In general, values ​​under 30 are considered oversold and values ​​over 70 are overbought. While these boundaries work well in sectoral markets, they tend to give false signals during trending periods.

The most commonly used framework is the 14-period RSI. However, this framework is optional and short term traders can use the 5 or 7 period RSI, while long term investors can choose the 21 or even 30 period RSI.

One of the most common uses for RSI is to spot divergences and alert traders to a possible trend reversal. After the basics, let’s look at some methods of using indicators for analysis.

The first thing a trader should learn is to spot a trend. Trending trading is welcome as an established trend gives trending trading an edge. Let’s understand this with some price promotions on cryptocurrencies.

An example of a sector-specific market

BTC / USD daily chart | Source: TradingView

In a tiered market, the moving averages cross and do not slope up or down over a long period of time. Look at the area surrounded by the ellipse in the graph above, where Bitcoin (BTC) stays within the range and the moving averages are flat. Such markets are trend-setting, difficult to predict and trade.

DOT / USD daily chart | Source: TradingView

As shown in the graph above, the Polkadot (DOT) price is stuck in a range and the moving averages are flat with no direction. When the price is mostly between the two limits, the market is said to be range-bound.

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

Identify an upward trend

BTC / USD daily chart | Source: TradingView

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

However, on October 21, 2020, the price broke the range and the RSI jumped into the overbought zone. At the start of a new trend, the RSI is usually in the overbought territory during the initial phase of the trend and the same can be seen here.

When the price goes up, the 20-day EMA begins to rise first, and then the 50-day SMA. When a trend starts, it usually lasts for a long time. Let’s look at another example of a trend.

DOT / USD daily chart | Source: TradingView

After staying in the 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 average lines began to move higher. Again, notice how the 20-day EMA is popping up quickly while the 50-day SMA takes a while to catch up.

In the above case, the RSI did not stay in the overbought territory for long, but above 50, suggesting a rule that does not apply in all cases.

Identify a downward trend

Unlike uptrends, which take a long time to form and sustain, downtrends are intense and, similar to the 2018 crypto bear market, can last for a long time or quickly reverse direction after a sharp decline.

BTC / USD daily chart | Source: TradingView

The above chart contains two important things that traders need to be aware of. First, the RSI has been making lower highs since late February, although prices continue to rise. This is a classic sign that the trend may be reversing. Again, this is not easy, but when traders combine signals with price action there is a high chance of avoiding disaster.

The bearish divergence of the RSI became important as the moving averages completed a bearish cross where the 20-day EMA fell below the 50-day SMA after staying above it for the past few months. This is a sign that short-term price action is easing and the trend may reverse.

After holding a range for several days, Bitcoin broke out on May 12 and the moving averages began to decline. This move along with the RSI in negative territory is a signal to traders that the trend is reversing. As long as the price stays below the moving averages and both the 20-day EMA and 50-day SMA continue to decline, the trend will remain bearish.

DOT / USD 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 flat and crossing each other. It’s difficult to call this the top as the price can go either way. However, if traders also look at the RSI diverging negative and warning of a possible reversal, they may be able to avoid the recent crash.

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

Remember, no signal is absolute!

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

Once investors are immersed in a trade, they should practice identifying the main trend as this can prevent them from going against the market and being burned out. The following articles discuss strategies for determining entry and exit points using indicators.

SN_Nour

According to Cointelegraph

Follow the Youtube Channel | Subscribe to telegram channel | Follow the Facebook page