How to Use Trading Indicators Effectively?
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Main Takeaways
Technical indicators use data to help traders identify patterns and evaluate market trends. Using a data-driven approach, traders can use these indicators to assist their market analysis and trading decisions.
Moving Average (MA), Moving Average Convergence Divergence (MACD), On-Balance Volume (OBV), Relative Strength Index (RSI), and Bollinger Bands are some of the popular indicators.
Binance allows users to display and customize technical indicators on their charts. Furthermore, traders can backtest these strategies, evaluating performance against historical data to refine their approaches.
Technical indicators are valuable tools in both crypto and stock tradersâ arsenal. These indicators use current and historical data to aid traders in identifying patterns, evaluating market trends, and making more informed trading choices. They also help in comprehending the market and spot trading signals. Furthermore, technical indicators can assist traders in creating data-driven trading plans and strategies while mitigating the influence of fear, uncertainty, and market hype.
This article explores some of the most popular technical indicators available to crypto traders to include in their trading toolkit.
Moving Averages
A moving average (MA) is a technical analysis indicator used to smooth out a cryptocurrencyâs short-term price fluctuation by calculating an average over a specific time period. It is a tool investors and analysts use to distinguish an assetâs actual trend direction from typical market noise. In addition, swing traders use MA to recognize potential market entry and exit points and support and resistance levels.
Moving averages are often categorized into simple moving averages (SMAs) and exponential moving averages (EMAs). The SMA sums an assetâs closing price over a certain period and divides it by the number of periods.
For example, a 10-day SMA would sum up the prices of the last 10 days and then divide by 10 to get the average. A new data set in SMA will displace the oldest data, which sets it apart from a basic average. For instance, if the SMA is calculated on a 5-day basis, the data set will continually be updated only to include the most recent 5 days.
On the other hand, an EMA emphasizes the most recent data points by assigning them higher weightage and value. It is more responsive to rapid price fluctuations and reversals than SMA, which treats all data inputs as equals.
Short-term traders favor EMAs over SMAs due to their faster price projection. Moving averages are considered lagging indicators since they depend on past price data. This makes them useful to traders when confirming a market trend rather than predicting the market movement.
How to use Moving Averages to gauge the trend?
There are three parameters to consider when adding MA to charts:
Time Period: Periods like 5-day, 10-day, 20-day, or 50-day for near-term trends and 100-day, 200-day, or 500-day for long-term trends.
Price Type: The price that will be used to calculate the average, i.e., closing price, low price, high price, average of high and low prices, etc.
MA Type: The type such as simple moving averages and exponential moving averages formulas.
Example
Suppose an asset's 50-day Moving Average is $1,000, and it is currently trading at $1,200. The upswing above the historical price ($1,000) indicates an upward trend. The new price being above the MA suggests a positive investor sentiment and a likely increased interest in the asset.
Moving Average Convergence Divergence (MACD)
Moving average convergence divergence (MACD) is a momentum or oscillator indicator that compares two distinct moving averages of a crypto asset to recognize a trendâs strength and its potential to reverse. Thus, it aids traders in identifying the direction and momentum of a trend.
MACD is determined by finding the difference between the 26-day EMA and the 12-day EMA. A 9-day EMA of the MACD is then plotted as a signal line. It is important to note that the two lines on the chart show the gap or distance between the two EMAs (12-day and 26-day). It doesn't represent the EMAs themselves; rather, it illustrates how far apart they are.
The signal line signifies the changes in price momentum and is considered a trigger for bearish and bullish signals. A histogram often represents the difference between the MACD and signal lines.
A decline in momentum and potential price decrease is evident when the two MAs move towards each other or converge. A divergence, or when the MAs move away from each other, often indicates an upward momentum and suggests a bullish signal.
How to use the MACD to gauge the trend?
The parameters for MACD include the following:
Time Period: Typically uses 12-day and 26-day periods for its EMAs and a 9-day period for its signal line.
Moving Averages: Relies on both short-term (12-day) and long-term (26-day) Exponential Moving Averages (EMAs).
Momentum: The gap between the two EMAs helps gauge the price momentum.
Example
Suppose youâre monitoring an asset using MACD.
If the MACD line crosses above the signal line, it indicates an upward momentum and a potential buy opportunity.
The MACD and signal line getting closer to each other hints at a trend reversal, i.e., short-term trends are rapidly slowing down compared to long-term trends. This signals a potential sell opportunity.
Relative Strength Index (RSI)
The relative strength index (RSI) is one of the most commonly used crypto trading indicators. It is used as a metric for the magnitude and strength of a cryptocurrencyâs price changes. RSI compares the size of an assetâs most recent gains against its most recent losses. This helps traders determine whether a cryptocurrency is oversold or overbought.
The RSI oscillator ranges between 0 to 100, with a line graph moving between the two extremes. A crypto asset with a reading above 70 signals that the market is overbought and could indicate a price correction. On the contrary, when the RSI oscillator reads below 30, it signals an oversold market and suggests a potential end to the bearish trend. A potential uptrend can also be identified when the indicator breaks above the centerline and vice versa.
However, the RSI momentum indicator may give false signals, especially in trending markets. It is more suited for range-bound markets.
How to use the RSI to gauge the trend?
The RSI parameters are:
Time Period: Usually used on a 14-day timeframe.
Oscillation Range: Ranges between 0 to 100 to indicate overbought (above 70) or oversold (below 30) conditions.
Example
Suppose an investor is monitoring the RSI of an asset; if the RSI value is:
Above 70: The asset is overbought (overvalued) or has experienced a surge in buying pressure that drove the price up. It could suggest a potential price correction.
Below 30: The asset is oversold (undervalued) or has experienced a surge in selling pressure and hints at a potential rebound.
On-Balance Volume (OBV)
On-balance volume (OBV) is a technical analysis indicator that tracks price and volume in the crypto market. It's a momentum tool used to measure the flow of volume in and out of an asset, thereby suggesting the strength or weakness of price moves.
The OBV works under the premise that when volume increases sharply without a significant change in the stock's price, the price will likely move upward, and vice versa.In essence, the on-balance volume indicator serves as an tool that uses volume flow to predict changes in price.Â
How to use the OBV to gauge the trend?
Volume: Volume plays a pivotal role in the OBV as it measures the strength behind a price move. A significant change in price accompanied by a high volume gives more weight to the price move, suggesting it might be more sustainable.
Price Direction: Depending on the asset's price movement from one day to the next, volume is either added or subtracted:
If the current price closes higher than the previous day's close, the day's volume is added to the OBV.
If the current price closes lower than the previous day's close, the day's volume is subtracted from the OBV.
Example
If the OBV starts to rise consecutively over a few periods, it indicates that volumes on up days are outweighing volumes on down days. This can suggest an upward price momentum and potentially a buy opportunity, especially if the asset's price is also rising.Conversely, if the OBV begins to decline over consecutive periods, it means volumes on down days are greater than those on up days, indicating a downward price momentum and potentially a sell signal, particularly if the asset's price is also declining.
If the asset's price is rising, but the OBV is not following suit or is moving in the opposite direction, this divergence may hint at a weakening of the ongoing trend, signaling a potential trend reversal in the near future. This can be a sign of caution for traders.
Bollinger Bands (BB)
Bollinger Bands (BB), coined after trader and financial analyst John Bollinger, measures a crypto assetâs market volatility, as well as overbought and oversold conditions. It helps traders determine when to enter or exit a position and identify possible trend reversals.
Typically, the BB indicator involves three lines â an upper band, a lower band, and a 20-day simple moving average (middle line). The upper and lower bands are used to measure the degree of price variation or volatility over a period of time. For instance, the upper and lower bands contract when the volatility is low and expand when the volatility is high. During high market volatility, they move away from the middle line and move towards it during low volatility.
In addition, when prices approach the upper band, it suggests that the market is overbought. The market is oversold when the prices approach the lower band. If it breaks through the lower band, it suggests a downtrend continues, and vice versa.
Generally speaking, using longer timeframes offers more accuracy since short periods are prone to noise and fakeouts.
How to use the BB to gauge the trend?
Time Period: Commonly uses a 20-day period for the middle band, which is an SMA.
Price Type: Typically uses closing prices.
Volatility: The bands expand and contract based on how erratic the price changes are.
Example
If an assetâs price shoots up and touches the upper band or crosses it, it signifies that the asset may be overvalued. However, if its price hits the lower band or goes below it, it suggests that the asset is undervalued or trading below its average. This hints at a potential buying opportunity.
How to Use Technical Indicators on Binance Trading Interface
Visualizing technical indicators on Binance Trading Interface
You can set up indicators with your preferred parameters and timeframes and visualize them directly on the trading chart.Â
For this, Navigate to the trading interface on Binance Futures, select the âTechnical Indicators'' option at the top of the trading screen, and pick the Technical Indicators you wish to display on the trading interface, as shown below.
Craft customized indicators and code strategies
Binance Futures offers more advanced traders the option to script and design their own technical indicators using Pine code. This adds a layer of personalization, allowing you to script indicators tailored to your specific trading ethos.
Beyond mere visualization, you can code trading strategies based on these custom indicators.
Backtest your strategy before going live
Before you take the plunge with a new strategy, Binance offers a robust backtesting tool. This allows you to test the waters by assessing how your strategy would have fared under historical market conditions.Â
This feature facilitates an in-depth examination of strategy-related metrics such as profitability, associated fees, and potential drawdowns over a designated time frame.
For a comprehensive walkthrough on customizing indicators and leveraging the backtesting feature, refer to the dedicated FAQ.
Closing Thoughts
Technical indicators offer insight into market trends, price direction, and volatility. They can allow traders to make better decisions and predict market movement based on current and historical market data and statistics. When building your trading toolkit, the choice of technical indicator boils down to your trading profile and strategy. Using multiple indicators can help traders minimize or eliminate false signals.
Further Reading
Risk Warning:
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This content is presented to you on an "as is" basis for general information and educational purposes only, without representation or warranty of any kind. It is not intended or should not be construed as financial or investment advice, nor is it to recommend or intend to recommend the purchase or sale of any specific product(s) or service(s).
Hypothetical Performance Results
Digital asset prices can be volatile. The value of your investment may go down or up, and you may not get back the amount invested. Any results posted herein are intended as examples only to provide you with a reference of what potentially could have made or lost trading with the technical indicators and tools, but are in no way a reflection of what you could have made or lost in the same situation. Therefore, you should not rely on the results as a representation of what your returns or losses would have been utilizing such technical indicators. There are numerous other factors related to the market in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, expressed or implied is made regarding future performance.
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