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What is a Technical Indicator?

What is a technical indicator?

A technical indicator is a mathematical pattern derived from historical data used by technical users to predict future price trends and make trading decisions. It uses a mathematical formula to derive a series of data points from past price, volume, and open interest data.

What are the most popular and useful indicators?

There are many indicators in traditional finance but the most popular indicators are:

  • Bollinger Bands
  • MACD
  • RSI

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What are Bollinger bands?

Bollinger bands are one of the most used trading indicators by market operators to compare the changes in the price of any asset and the relative value of its price over a period of time.

This indicator was created in the 1980s by John Bollinger and consists of three bands that are drawn superimposed on the price evolution chart.

  • The central band is a moving average. Normally, a simple moving average (SMA) calculated with 20 periods is used, which represents the evolution of the average of the last 20 periods over time.
  • The upper band is calculated by adding to the value of the simple moving average 2 times the standard deviation of the moving average.
  • The lower band is calculated by subtracting from the simple moving average 2 times the standard deviation of the moving average.

The standard deviation is a statistical parameter that provides a good indication of changes in market value since it takes the variation of the values ​​that comprise the average. For example, a period of 9 and another of 11 gives 10 as an average ((9 + 11) / 2 = 10), and that average will have a standard deviation of 1. On the other hand, the resulting standard deviation of an average between 1 and 19: the mean, again, will be equal to 10 ((1 + 19) / 2 = 10), but the standard deviation will be 9.

Therefore, the use of this parameter to calculate the bands ensures that they will respond quickly to price variations, reflecting periods of high and low probability of change. Likewise, the band between the upper and lower bands contains, statistically, almost 90% of the possible price variations. This means that any price movement outside the bands is highly unlikely and thus of particular importance.

For these reasons Bollinger bands are used to:

  • Identify periods of high or low volatility.
  • Identify trend changes in the price.
  • Identify strengths or weaknesses in the price trend.

One of the most used cases for these bands is to define a trend of a potential break using it as a volatility indicator. When the price is in a range, the bands will be squeezed. If this situation continues for some time, the more time the bands spend together, the stronger the breakup will be.

How to trade using these bands?

Users usually use Bollinger Bands in two ways. 

The first one is to go with the trend. If the price is in a range, when the price breaks the range for one of the sides, you will put the order and go with the trend. Also, you should set a Take Profit and Stop Loss. The stop loss will be settled in the other bands (not broken bands) and the take profit order can be adjusted as the same as the stop loss but on the other side.  

This can be explained better with a real example.

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In the 15M BTC USDT chart on BitMart, we can observe two ranges. When the prices went below the lower limit, the user should pull the trigger and enter in a Short position on BitMart Futures. Set the Stop Loss (SL) above the upper band and the Take profit at the same distance. So, you can observe that both of them were successful. This is a basic strategy and is easy to use. 

You can use this strategy in any timeframe but usually, this is used on M5 or M15 charts. 

The second case is easy too but it’s against the trend. users must know a bit more about Candlestick patterns, and specifically about reversion patterns. So, once they go above the upper band (Short opportunity) or below the lower band (Long opportunity), that’s the start of this setup, then users must focus on finding a reversal pattern using candlesticks. 

Once the user finds a potential reversal candle, must wait for the confirmation, which is a break above the last candlestick maximum (Long) or lower than the last candlestick minimum (Short). The Stop Loss must be settled below the reversal candlestick pattern (Long) or above the reversal candlestick pattern (Short). The Take profit order should be settled around the mid-brand. Users must evaluate the risk to figure out if the opportunity is good or not. They can use the tool named Short Position or Long Position on BitMart charts. 

So, let’s focus on this example

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This is the 15M BTC/USDT chart on BitMart. The first case is not good to take because of the setup, there is a break on the band, also the reversal candlestick pattern (Almost completed engulfing candle) but the Risk/Profits ratio is not good because the Stop Loss is greater than the Take profit. It was successful but it’s better to let it go.

The second one is perfect. The price went below the band, and then a perfect reversal pattern. The Risk/Profit ratio is quite good. The user must pull the trigger using a Long on BitMart and set the TP and SL. This trade was successful. 

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MACD

What is the MACD?

The MACD (Moving average convergence/divergence) is a moving average of convergence/divergence that follows the trend created by Gerald Appel. It is a momentum indicator that captures the trend and shows the relationship between two moving averages of prices.

The MACD consists of the following components by default:

MACD value = (EMA 12 periods - EMA 26 periods)

Signal line = MA 9 from the calculation above

MACD histogram = (MACD value - signal line). It’s the distance between the lines.

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How can we trade with the MACD?

There are two practical methods to trade with this indicator:

When the MACD line crosses above the signal we open positions and when the first crosses below the other we close positions. This is the trade signal.

When both lines cross above the zero level we open the trade and when both cross below we close our trade.

users don’t consider MACD a strategy by itself, it’s like a confirmation. It is used to confirm entries due to the divergences or the trade signal. It’s common to take trades when MACD has a divergence or the trade signal and the price is on Support (Long) or Resistance (Short). 

RSI

The RSI indicator is one of the most used in technical analysis. Despite its simplicity, it is a key indicator in trading since it allows evaluating the strength of the price variation of any asset listed on the market.

What is the RSI indicator?

RSI stands for Relative Strength Index. As its name suggests, the RSI measures the momentum of changes in the price of an asset to assess whether the price of the said asset is oversold or overbought.

The RSI is a technical indicator that falls under the category of oscillators. This means that its value is between 0 and 100, so it is graphically represented by a continuous line that moves within that interval. The RSI was created by J. Welles Wilder Jr in 1978 and has become popular and widely used ever since.

The RSI provides a measure of how well an asset's price is doing against itself. This translates, for practical purposes, into measuring whether an asset is overvalued or undervalued:

  • An RSI reading above 70 is considered to indicate that an asset is overbought or overvalued. Therefore, an RSI above 70 would be anticipating a possible corrective price movement.
  • Conversely, an RSI reading below 30 indicates that an asset is oversold or undervalued, so an RSI at this level could signal a bullish price reaction.

How to use the RSI?

As indicated, the RSI is one of the most used indicators in trading. This is due to the amount of information it can provide to users who employ technical analysis to define their trades.

This section will explain how to use RSI to optimize trading results. For this, it will be indicated how to use the RSI to:

  • Identify price trends.
  • Get trading signals.

To identify trends with the RSI, users should pay attention to the indicator. When the RSI is showing higher lows, it means the price is in an uptrend. When the RSI is showing lower highs, means the price is in a downtrend. 

As with the MACD, users don’t use RSI as a  strategy itself. If we get a divergence, it means we have a potential reversal. RSI is confirmation to pull the trigger and usually is combined with the price action. If we get a divergence on the RSI, which can be that the RSI is showing a higher low but the price had a lower low, and the price is on a potential support area, that’s a good possibility to take a Long position on Futures setting the Stop Loss below the support and the Take profit near to a resistance area. 

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This is 1H BTC/USDT chart on BitMart, the price in the first case (yellow) is showing higher highs but the RSI indicator is showing higher lows, so, this means we are having a divergence and as the price was on a resistance area, this was a great opportunity to place a Short position. 

In the second case (white), users can see a divergence too because the price had lower lows and the RSI is showing higher lows, so, this means users can place a Long setting the Stop Loss below the lows and the Take profit in the next resistance. 

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Disclaimer:  

Cryptocurrencies are subjected to high market risk and volatility despite high growth potential. Users are strongly advised to do their research and invest at their own risk. BitMart will do its best to list only high-quality coins, but will not be responsible for your investment losses.  

All content produced by BitMart is intended solely for educational purposes. This should not be taken as financial or investment advice. Individuals are advised to perform due diligence before purchasing any crypto as they are subject to high volatility. 

 

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