Trading Cryptocurrencies: Three Basic Common Technical Indicators

Introduction

Cryptocurrencies (or crypto) has been thrown in the limelight recently with Bitcoin’s meteoric rally this year, the cryptocurrency having risen for the fifth month straight since February 2019. Bitcoin most recently hit a high of US$13,775, before its price corrected to US$10,085  (as of 31 July 2019). Bitcoin’s rally in June was no doubt spurred on the market’s positive reception of the announcement of Libra coin, Facebook’s proposed cryptocurrency to facilitate virtual payments across its ecosystem of 2.4 billion users.

Given what we have seen of the crypto market in general, there can certainly be meaningful trading opportunities given proper research, understanding, and action. However, how would you know when to enter the cryptocurrency market? Should you take a position on a particular cryptocurrency now, or hold off? This is where technical analysis may assist traders with assessing, analysing and answering these common questions.

In this blog post, we are going to run through three commonly used technical indicators that are applied in trading cryptocurrencies: Moving Averages, Fibonacci Retracement and Relative Strength Index. We will also illustrate the application of these technical indicators using various cryptocurrency pairs. 

What is technical analysis?

Technical analysis uses data from past price movements to predict future price movements. Typically, traders use technical analysis to identify patterns and signals that form on price charts to determine how the asset would move in the future. Technical indicators are usually automatically calculated and applied for you on most charting applications. 

Technical analysis is based on three main assumptions:

  1. Markets already fully value the asset and price movements are due to the forces of demand and supply.
  2. Prices move in trends. 
  3. Prices often follow predictable patterns due to market psychology.

Most people view technical trading as a very calculated and statistical style of trading. Since technical indicators are more precise for short term price movements, they may be used for day trading and swing trading (where traders hold assets for a short period – i.e. generally 1 to 2 weeks).

We now turn to three of the more popular and commonly used technical indicators in trading cryptocurrencies. 

#1 – Moving Averages

The moving average of an asset can be seen as a trend following indicator which tells you about the price level of an asset based on its previous prices. The moving average is calculated over a certain number of fixed time intervals, and common time periods used are the 50 day and 200 day moving averages.

How do you interpret the Moving Average

The moving average is graphed as a line on the price chart of a cryptocurrency. There are two types of moving averages, the simple moving average (“SMA”) and the exponential moving average (“EMA”). 

The SMA is calculated using an average of the previous prices divided by the number of time periods, and therefore provides the average of price data. 

The EMA is calculated using the SMA but with a weighted average which favours more recent prices. 

In this manner, the main difference between the SMA and EMA is that under the EMA, recent price data will affect the moving average more, and older price date will have less impact in the calculations. 

The moving average offers insight to the asset by comparing their current price to an average of its prices across a time period. Traders usually plot two moving averages of different time periods  together, and depending on the interactions between the two moving averages (e.g. where a moving average crosses over or under another moving average), that may be employed as a trading signal for a change in momentum. 

Generally, when a shorter period moving average crosses above the longer period moving average, it is taken as a bullish signal. When a shorter period moving average crosses under the longer moving average, it is taken as a bearish signal.

How do I use the Moving Average while trading?

Moving Average Bearish Crossover for TRX/BTC

In the above example, we plotted a 50 day and 200 day EMAs against the daily price chart of TRX/BTC. On 30 April 2019, we observe that the 50 day EMA crossed under the 200 day EMA. We observe that the cross under further confirmed the general bearish trend of TRX/BTC for the first two weeks of May 2019. 

#2 – Fibonacci Retracement

Fibonacci Retracements are horizontal lines that divide the distance between two extreme points on the price chart according to the Fibonacci ratios: 23.6%, 38.2%, 50%, 61.8%, and 100%.

Fibonacci Retracement lines are drawn by:

  1. Identifying the highest and lowest price in the time frame that you are interested to analyze and drawing horizontal lines at each of these price levels
  2. Divide the distance between those lines by the Fibonacci ratios (23.6%, 38.2%, 50%, 61.8%, and 100%) and draw a horizontal line at each level. 

How do you interpret Fibonacci Retracements?

Fibonacci Retracement lines are used to identify support and resistance levels.  Support levels area price levels where asset prices do not fall below over a period of time due to a convergence of demand. Conversely, resistance levels are price levels where an uptrend in prices faces resistance. 

The Fibonacci Retracement lines reflect possible support and resistance levels which can be used to identify points of entry and exit for a trade. When the price of a cryptocurrency approaches the retracement lines, there is a possibility that the price of a cryptocurrency will either bounce off the line or cross the line to reach the next support or resistance level. 

How do I use Fibonacci Retracement lines when trading?

What the Fibonacci Retracement Tool looks like on a ETH/BTC price chart

Observe that the highest and lowest points in the time frame between December 2018 and February 2019 have been identified using the circles. We then used the Fibonacci Retracement tool to help us divide the vertical distance according to the Fibonacci ratios. The horizontal lines each mark the possible support and resistance levels.

If you look closely at the time period between March 2019 and April 2019 (as denoted by the yellow box), you will notice that the price of the ETH/BTC pair was always hovering near the price of 0.035BTC but never rising above it. We can perhaps infer that there is some resistance at the 0.035BTC price level. This price level corroborates with the 61.8% Fibonacci Retracement level that we identified in Feb 2019. This is an example of Fibonacci Retracement tool to determine the support and resistance levels.

#3 – RSI

The Relative Strength Indicator (“RSI”) is used as a momentum indicator which measures the magnitude of recent price changes. The RSI is determined with a 2-step calculation:

The formula to calculate RSI

The RSI is generally measured over a 14-period timeframe (it could be 14 hours, days or months depending on what your time period of interest is). Through the formula above, we can see that RSI will rise as the number and size of positive gains increase and decrease when losses increase. The RSI is calculated on a scale of 0 to 100 and is usually shown as a line graph on charting applications.

How do you interpret the RSI?

RSI can be used to identify trend directions and reversals.

Centreline crossovers are usually used to determine trends. When the RSI indicator crosses 50 in a positive direction (from below) it indicates a positive trend in price and the reverse is true when the RSI crosses the centreline from above.

The magnitude of RSI can also give us information about reversals. An RSI value of 70 and

above indicates that the cryptocurrency is becoming overbought, signalling a negative

correction in the near term where prices will adjust downwards. Conversely, an RSI value of 30 and below indicates that the cryptocurrency is becoming oversold and suggests an impending positive correction.

How do I use RSI while trading?

What the RSI chart looks like on a trading chart (LTC/BTC)

Let’s use the price chart of LTC/BTC between 24 May 2019 to 12 June 2019 as an example. The RSI is represented on the line graph below the candlestick pattern.

Firstly, RSI can be used to confirm the direction of a trend. When the RSI indicator crosses 50 in either a positive or negative direction, it is known as a centreline crossover. Such crossovers can be used to indicate either a falling or rising trend. On 24 May 2019, we see the RSI change from 38 to 51, i.e. a centreline crossover from below occurred. Subsequently, prices started moving upwards.

Secondly, RSI can also be used as an indicator to find trend reversals. As mentioned above, an RSI above 70 shows that a cryptocurrency is overbought which may be a prelude to a negative correction. On 12 June 2019, we see that the RSI moved from 69 to 83 over the previous 3 days. LTC became overbought, triggering a negative correction which caused prices to move back down.

Applying a combination of technical indicators

Now that we have briefly introduced how each of the above technical indicators work, let’s use a combination of them to provide more clarity on how a particular cryptocurrency may perform in the near future.

Combined example based on EOS/ETH price chart

First, we start out with plotting out the Fibonacci lines to find the various support and resistance level for EOS/ETH. We take the lowest and highest point as shown above. We notice that the price tested the 38.2% resistance level on 30 May 2019, but was not able to breakthrough this level. We might infer that there the price of EOS/ETH might bounce off the resistance and go lower. 

Subsequently, we see a centreline crossover on the RSI on 3 June 2019, which signalled a bearish sentiment. This was confirmed by the drop in the price of EOS/ETH. 

Further along in the chart between 14 to 23 June 2019, we notice that EOS/ETH is trading sideways at the 161.8% level. We then see the 50 day EMA cross the 200 day EMA from above on 29 June 2019. This crossover signalled bearish sentiment, and this was confirmed by EOS/ETH falling through 161.8% level. 

Conclusion

Technical analysis is undeniably an important tool for traders. However, it is important to bear in mind that it is a statistic-based analysis tool and is not to be taken as a sure fire way to predict price movements. While the technical indicators you have selected may indicate a certain price direction, there are certainly instances where the market moves in a direction different from that being suggested. Therefore, before taking a position in the market, it is crucial to do your research thoroughly, and to take appropriate steps to mitigate risks.

For completeness, fundamental analysis is commonly taken to be the other half of the trading equation. In the context of trading cryptocurrencies, it pertains to assessing and evaluating the intrinsic value of the relevant cryptocurrency as well as the value it provides to users. Both technical and fundamental analysis can and should be used in tandem to provide a more holistic assessment of any cryptocurrency.

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Disclaimer: This blog post does not constitute advice (legal, financial or otherwise) on any matter discussed and, accordingly, should not be relied upon as such. Hydra X does not make any representation or warranty as to the accuracy, completeness or correctness of the information or opinions set out in this blog post. Opinions expressed are subject to change without notice. This blog post does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee, and Hydra X accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this blog post.