When candlestick patterns fail to provide enough information about future price action, indicators are there to help. Many beginners start their trading journey by experimenting with indicators and determining which ones best fit their style. But how does one pick an indicator out of hundreds of available options, and which make sense for trading cryptocurrency?
An indicator supports the trader’s goal to discover market structures and incoming price movements. Indicators of course cannot predict prices with 100% certainty. And traders can use the same indicator to draw two different conclusions.
In this article, I will brief you on the top 5 crypto indicators and provide you with a basic overview of how they work and how to use them.
What is an Indicator?
Indicators are a trader’s best friend. Although they cannot predict prices with 100% certainty, indicators support traders in determining market structures and incoming price directions. But what is an indicator in the first place?
As the name implies, indicators provide indications on where the market is headed. An indicator is essentially a combination of historical price data and complex mathematical models. Price data goes in, the model processes the data and generates an output.
The resulting output produced by the indicator’s formula is then drawn out on a chart. The trader interprets this information along with other data-points to reach a conclusion regarding the market’s future behavior.
Types of Trading Indicators
Two types of indicators exist: lagging and leading.
A lagging indicator shows the environment and factors that influenced the price at a certain point in the past. We use and compare this data to the present moment to determine if similar factors are once again at play. For example, trend indicators, which fall under the lagging subtype, show whether an asset behaved bearish or bullish.
A leading indicator tries to predict future price action. Momentum indicators fall under this category. They evaluate the speed at which prices change and determine whether the direction an asset moves is still feasible.
We can divide indicators further into five categories:
Relative strength indicators (leading)
Momentum indicators (leading)
Trend indicators (lagging)
Mean reversion indicators (lagging)
Volume indicators (either lagging or leading)
In the next section, I will introduce you to five of the best indicators for crypto trading.
The 5 Best Indicators for Crypto Trading
Relative Strength Index (RSI)
Relative Strength Index is the number one indicator crypto beginners use. RSI indicates the strength or weakness of an asset by determining whether it has been oversold or overbought. This indicator uses the following formula:
RSI = 100 – 100 / (1 + RS).
RS = Average of X periods closes up / Average of X periods closes down.
X = Generally 14, but can be customized to any number.
RSI ranges between 0 and 100. There are numerous ways to interpret RSI, but technical analysts generally categorize an asset as:
Oversold – If below 30
Overbought – If above 70
Whenever an asset’s RSI is between 30 and 70, the RSI is considered to be neutral. To use this indicator, sell when an asset is overbought and buy when oversold.
Crypto traders like to combine RSI with hidden divergences. A hidden bullish divergence is when RSI falls but the price rises. If RSI rises but the price falls, it indicates a hidden bearish divergence.
MAs (Moving Averages)
Moving Averages are another powerful tool. They are a lagging indicator that provides a better picture of how price action played out in the past. Traders use them for a number of cases, such as determining:
Support and resistance levels
Entries and exits
We can use the line of an MA to determine trends by observing the line’s slope. If the slope rises, the asset is bullish. If the slope falls, the asset is bearish.
When multiple MAs come into contact, the result is a crossover. A crossover is a sign of major volatility in the future. We refer to positive crosses as a Golden Cross and negative crosses as a Death Cross.
The example above shows a golden cross that occurred after the 200-day MA crossed the 50-day MA. Bitcoin went on to increase from $30,000 to $52,000 a month after the cross occurred.
Each MA is assigned a number. This number shows the number of candles calculated by the indicator’s formula. For example, the 200-day MA has an input of 200 candles. Higher MAs are more suitable for long-term trading, while shorter MAs are better for short-term and intraday trading – usually between 7 and 25.
Ichimoku cloud represents a complex trading style and indicator system originating from Japan in the late 60s. This collection of indicators shows momentum, trend direction, support, and resistance levels. Ichimoku cloud bears a resemblance to MAs.
There are several important facts to keep in mind when using Ichimoku:
Prices above the cloud are good, otherwise bad
Thicker clouds indicate a stronger trend
Green clouds are positive; red clouds are negative
Prices breaking above or under the cloud indicate a trend reversal
The lines at a cloud’s external border act as support or resistance depending on where the price is positioned
The Ichimoku cloud consists of five grand lines called:
Kijun-sen (base line)
Tenkan-sen (conversion line)
Chikou span (lagging span)
Senkou Span A (leading span A)
Senkou Span B (leading span B)
Ichimoku cloud is a popular trading style because it visualizes key information in a digestible format. However, it is also the most difficult style due to its high complexity. Traders are therefore advised to use Ichimoku in combination with other indicators.
John Bollinger invented Bollinger Bands in the 1980s . Technical analysts use this indicator to discover overbought and oversold market conditions, as well as the market’s volatility level.
Structurally, these bands consist of an upper band, lower band, and a moving average line in the middle. The band’s surface expands when volatility is high and contracts closer to the MA when volatility is low.
The upper and lower band form a range inside which the asset moves.
An asset’s price structure needs to fall in line with Bollinger bands. Traders expect a trend reversal If the price deviates from the upper or lower band. One can also use the two bands to determine support and resistance levels. Bollinger bands use Simple Moving Averages (SMAs) by default, calculating 20 candles as the standard.
Moving Average Convergence Divergence (MACD)
MACD is a trend and momentum indicator that uses two moving averages to determine an asset’s status. This indicator relies on exponential MAs (EMA) to anticipate the momentum of a trend and its sustainability.
MACD features three key components:
MACD: 12-period EMA - 26-period EMA.
Signal Line: A 9-period EMA.
MACD Histogram: MACD signal line.
MACD is calculated by subtracting the 26-period EMA from the 12-period EMA. Positive MACD indicates a bullish trend, while negative MACD indicates a bearish trend. Traders can use the MACD’s slope to determine momentum.
Traders can also find bullish and bearish crosses in MACD. When the MACD crosses the signal line, we can see that as a positive outcome which signifies a good opportunity to buy. The opposite is true if the MACD heads below the signal line.
To learn more about indicators and relevant TA data, we recommend checking out the following links:
Marko is a crypto enthusiast who has been involved in the blockchain industry since 2018. When not charting, tweeting on CT, or researching Solana NFTs, he likes to read about psychology, InfoSec, and geopolitics.