Most crypto traders can be divided into HODL investors — or "hold on for dear life" — or short-term traders. The latter group relies on technical analysis to help inform their decisions, including qualitative chart patterns or trend lines and quantitative technical indicators.
Let's take a closer look at how technical indicators play a role in crypto trading and three popular indicators to get you started off on the right foot.
What Are Technical Indicators?
Technical indicators are the curvy lines that you see above, below or over the top of a price chart. While chart patterns and trend lines are drawn onto a chart, technical indicators are a series of data points calculated by applying a formula to the price of a security at different points in time.
For example, a 200-day moving average calculates the average price over the past 200 days and creates a point on the chart's current period. You can easily see if the current price is above or below the average price over the past 200 days, which could indicate everything from the trend to momentum.
Traders use technical indicators in a few different ways:
- Signal - Technical indicators can provide buy or sell signals to traders. For example, a bullish moving average crossover could be a 'buy' signal for some traders.
- Confirmation - Technical indicators can provide confirmation of a bullish or bearish trade. For example, a bearish RSI downturn could confirm a breakdown from trend line support.
- Prediction - Technical indicators can be used to make predictions about future price movements, although their predictive capabilities are debatable.
Technical indicators are best used in conjunction with other forms of technical analysis to paint a complete picture. A downturn in a single technical indicator is not a reliable trading signal — traders should instead look at the wider price action and other forms of technical analysis for confirmation.
3 Best Indicators For Crypto Trading
There are hundreds, if not thousands, of different technical indicators — and more come out every year. These indicators range from basic moving averages to advanced algorithms designed to measure a variety of different price behaviors. That said, most traders focus on just a handful of them.
1. Bollinger Bands®
Bollinger Bands® show reduced volatility in December and heightened volatility in March.
Bollinger Bands® provide a channel of expected price volatility. The middle of the channel is typically a 20-day moving average and the upper and lower bounds are two standard deviations in each direction. The indicator provides an idea of what traders can expect to see.
Most traders look for bullish "W" and bearish "M" patterns whereby the price touches the upper or lower bounds of the Bollinger Band® twice. In addition, the width of the Bollinger Band® can be an important indicator of how volatility has been changing over time.
2. Moving Average Convergence-Divergence (MACD)
MACD shows a bullish crossover in mid-March that could have been a ‘buy’ signal.
The moving average convergence-divergence, or MACD, shows the interactions between a short-term (12-day EMA) and long-term (26-day EMA) moving average and a signal line (9-day EMA). The difference in movement between the long-term and short-term moving averages can be an important momentum indicator.
Most traders consider the short-term moving average crossing above the long-term moving average to be a bullish signal and vice versa for a bearish signal. Advanced traders also look for divergence when the MACD is moving opposite of the price. If that happens, the price could breakout in the MACD direction.
3. Relative Strength Index (RSI)
RSI shows oversold conditions following the big drop in mid-March.
The relative strength index, or RSI, is an oscillator that ranges from 0 to 100. As the ratio of average gains to average losses, the indicator provides an important measure of bullish or bearish momentum. It's commonly used alongside the RSI as the two primary indicators on a price chart.
Most traders look for bullish oversold conditions when the RSI value trends toward 30 and bearish overbought conditions when the RSI trends toward 70. Oftentimes, the RSI level can set a bullish or bearish bias that traders can use when looking for trading opportunities using other indicators.
Best Practices to Keep in Mind
Technical analysis is helpful for analyzing price trends, but it's not a silver bullet or guarantee. When using technical analysis, it's important to use multiple indicators and/or chart patterns to create a holistic assessment of the market, while taking the current price action into account.
Keep these best practices in mind:
- Practice Makes Perfect. Practice trading using technical indicators on a demo (or paper trading) account before committing any real capital.
- Experiment. Try out different technical indicators to discover what works best for you rather than trying to adopt someone else's trading system.
- Risk Management. Always use risk management techniques, such as position sizing, to mitigate risks and avoid taking on too much risk with any given trade.
- Seek Confirmation. Always use multiple forms of technical analysis to analyze each trade from multiple angles rather than relying on a single analysis.
By keeping these best practices in mind, you can increase your chances of finding profitable trading opportunities.
The Bottom Line
Crypto traders rely on technical analysis to identify potential trading opportunities. If you're just getting started, check out the three popular technical indicators mentioned in this article as a starting point for your own analysis before exploring the hundreds of other indicators out there.
In addition to technical indicators, short-term traders should ensure that they're keeping proper records for tax season. ZenLedger makes it easy to aggregate transactions from multiple wallets and exchanges and automatically calculate capital gains and losses for tax purposes.