Indicators come in quite handy when it comes to trading stocks and cryptocurrencies. There are many indicators to measure volatility, gains and losses, strength of the coin, momentum and the trend of the market. These indicators can be used based on what a trader tries to gauge.
Analysts state that it is a good practice to use a combination of indicators that measure different parameters of a security to get a better understanding of the market. In this article, we will consider the Exponential Moving Average (EMA), Moving Average Convergence and Divergence, and Bollinger bands.
Exponential Moving Average (EMA)
An exponential moving average is an advanced version of a simple moving average (SMA). The EMA is advanced as it gives more weightage in the equation to the present prices, whereas the SMA distributes the prices across the elements. This means that the EMA is much more sensitive to present prices than the SMA.
Source: (Tradingview)
So let’s begin by understanding what an SMA is. A simple moving average is simply the average of something. In terms of crypto, it is the addition of the prices of crypto for the stipulated number of days divided by the number of days.
For example, let’s assume that the price of BTC was $80,000 on Monday, $78,000 on Tuesday, and $82,000 on Wednesday. So the average price for the three days would be the sum of the prices for the three days divided by 3. So, it adds up to $240,000 divided by 3, which is $80,000.
However, the problem with the SMA is that it dissolves the present value of the prices seamlessly into days, and the equation loses its accuracy. Referring to the example above, if a trader uses the SMA on Wednesday, he/she will get $80,000 as the average price, but in reality, the price of BTC is $82,000, and it could be misleading.
This loophole of SMA needs to be addressed, especially when dealing with the volatile crypto market. A cryptocurrency could show huge differences in a short period, and overlooking its present price could be misleading. As such, the EMA is preferred.
How the EMA is commonly used
Generally, long-term investors and traders use the 50-day EMA and the 200-day EMA to get a better understanding of the market, while day traders and scalpers use shorter timeframes like the 8-day and 20-day EMAs to go with their business.
Golden Cross and Death Cross
Source: (Tradingview)
Golden Cross
A Golden cross occurs when the short-term moving average, which is the 50-day EMA in the above example, rises above the longer-term 200-day EMA. When traders spot a golden cross, they recognize it as the start of a bull market that triggers a buy signal. However, according to the book, a golden cross has three different phases.
The first phase is where the downtrend exists in its latter stages. During this phase, although the price may be on a downtrend, the selling pressure will be slowly overtaken by stronger buying interest.
The second phase is the emergence of a new uptrend. This occurs when the short-term moving average crosses the long-term moving average, which is above, from below.
The latter stage is when the uptrend is prolonged with the bull market in play. However, to confirm that the bull market is prolonged, both the moving averages should act as support levels when market corrections occur. The market is considered to be bullish as long as the 50-day EMA and price remain above the 200-day EMA.
Death Cross
A death cross is the inverse of a golden cross. The death cross occurs when the shorter EMA, the 50-day EMA in this case, crosses the longer EMA, the 200-day EMA, from above and drops below it. When this happens, traders consider it to be a bearish market and start selling. Just like the golden cross, the death cross also has three phases. During the first phase, the buying momentum tapers off as the uptrend reaches its peak, and the selling takes over.
The second phase is when the price of the security falls until the 50-day EMA crosses the 200-day EMA from above. When this happens, it indicates the beginning of a bearish trend. The last phase is when the securities stay in the bearish trend for a long period. But if the security recovers after a short dip, then the death cross is considered to be a false signal. However, during this period, many traders often buy the dip and wait for the prices to recover.
Moving Average Convergence and Divergence (MACD)
The MACD, although considered a technical indicator, is more of an arrangement of the EMA rather than an indicator by itself. The MACD line, derived by subtracting the 26-day EMA from the 12-day EMA, is a momentum or trend indicator. When the MACD falls below zero, it means that the security is not performing well. And, when the MACD records a positive value, it depicts that the security is doing good.
Source: TradingView
Apart from the MACD line being positive and negative, there is yet another feature to the MACD indicator, the signal line. The signal line shown in the chart above acts as a reference line to the MACD. It is a smoothed line (average) of the MACD, and helps to gauge how well the MACD line is doing compared to its past. When the MACD line is above the signal line, the security is considered to be performing well above par, and when it is below the signal line, the security is performing below average.
How is MACD commonly used?
Source: TradingView
When the MACD (purple) is in the negative zone, traders wait for it to cross the SMA from below. Once the crossover happens, traders set long positions, anticipating an upward trend.
Source: TradingView
When the MACD is deep in the positive zone and the buying pressure starts to wane, traders usually wait for the MACD line to cross below the signal to short their assets.
Divergence
Source: TradingView
The MACD line usually moves in unison with the price of the security; that is, when the price makes a higher high, the MACD follows. However, there could be instances where there could be divergence. For instance, the above chart shows MACD making lower highs while the prices make higher highs. When this happens, it means that the uptrend of the security is coming to an end, and there could be a dip in prices.
Bollinger bands
Source: TradingView
The Bollinger bands were introduced by analyst John Bollinger back in 1980. This indicator that measures volatility consists of three bands: the upper band, the middle band, and the lower band. The Bollinger bands are used to determine whether the security is overvalued or undervalued in the market. Based on how the market behaves, the Bollinger bands expand and contract. When the bands expand, it means there is high volatility, and when they contract, the prices move sideways or consolidate.
Source: (TradingView)
Imagine the upper and lower bands like the curbs on either side of the road. Whenever you drive a vehicle and go too close to the curb, you obviously steer the vehicle towards the middle of the road. In the same way, when the price of the security touches the upper or lower Bollinger band, there is a high tendency (95%, based on 2 standard deviations) for the prices to return towards the middle band.
How are Bollinger bands used?
When the security reaches the lower band, traders expect the prices to ricochet off the lower band and move towards the middle band. As such, traders open long positions when the security touches the lower band and short positions when the price touches the upper band.
Conclusion
Although indicators signal and tend to forecast the prices of security, however, there are instances where the price goes against what indicators say. Macroeconomic factors, geopolitical factors, wars, and fed rates are some of the factors that play a huge role in how these securities behave. As such, traders may need to look beyond technical analysis and indicators before making financial decisions.
