Technical Indicators

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Technical Indicators

What are Technical Indicators?

There are many different methods that investors use to try and predict the future outcome of an asset’s market value. The two main methods are fundamental analysis and technical analysis. Fundamental analysis utilizes macro and microeconomic factors, as well as current financial factors, to determine an asset’s value. Technical analysis uses different technical indicators, or equations representing analyzed historical data, to try and determine the future price. Technical indicators can be based on a multitude of different trading factors and data, such as historical price trendstrading volume, asset activity, and many others. Unlike fundamental analysis, which uses financial and economic information to determine the value of an asset, technical analysis focuses on statistical and historical patterns to anticipate an asset’s price.

Since technical indicators are focused on trading data instead of the asset’s financial underpinnings, technical indicators and technical analysis are used by traders who want to predict short-term price outcomes. Technical indicators are designed to analyze market trends instead of the underlying value of the asset; they are mostly utilized by short term, active, or day traders. Longer-term investors tend to rely more on intrinsic long term value, so they may only utilize technical indicators when they need to determine the appropriate time to make a trade.

The Four Different Types of Technical Indicators 

When breaking down the different varieties of technical indicators, they can be generally placed within 2 categories, overlaying or oscillating indicators. Overlaying indicators use the same price scale to plot data for analysis, while oscillating indicators use a scale varying from the historical price chart.

From there, you can continue to differentiate technical indicators between four additional categories:

• Trend indicators

• Momentum indicators

• Volatility indicators

• Volume indicators

Each sub-category uses different statistical methodologies to analyze the asset and try to predict its near future market price.

Trend Indicators

The first type of technical indicator we’ll explore, the trend indicator, is used to measure the direction and velocity of a price trend, or how strong the trading trends appear compared to a pre-established average. If the indicator shows the price is above the stated average, it is seen as a positive and bullish sign for the asset’s market; if the indicator dips underneath that average, it is seen as a negative and bearish signal. The main types of trend indicators used are Moving Averages and Moving Average Convergence Divergence (MACD). These indicators are referred to as lagging indicators and can be found on exchanges such as Binance.

3 Moving Averages
A BTC/USDT price chart showing 3 different Moving Averages overlaying the price chart – Binance.com

Momentum Indicators

Momentum indicators are used to analyze price velocity or volume by comparing different prices over time. These indicators are created by comparing the differences as well as the price acceleration at the current closing prices to previous closing prices. Since additional data is needed to create these indicators, they are graphed above or below the price chart, not overtop it. When a change in momentum is indicated by one of these signals, investors know there can be a change in price, and how fast that change may take place. Popular examples of these types of indicators are the Relative Strength Index, or RSI, and the Stochastic Oscillator, and can be found on exchanges such as eToro.

RSI momentum indicator
A BTC/USD price chart with the RSI momentum indicator underneath – tradingview.com

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Volatility Indicators

Volatility indicators are used to measure the range and speed of price movement from its average directional value. In other words, how fast and in what direction is the price going compared to charted averages. Volatility indicators can be used when prices are going either direction and provide a range of price points versus the risk of breaking those points to determine the asset’s volatility. Assets with low volatility do not tend to stray off their market established price direction, while high volatility assets are much more likely. The most common volatility indicators are Bollinger Bands and Standard Deviation.

Bollinger Bands
An example of Bollinger Bands on a BTC/USD price chart – tradingview.com

Volume Indicators

Also known as resistance indicators, volume indicators measure the strength or weakness of a market trend based on resistance levels and trading trend speeds. When there is a strong trend of directional trading volume, it can lead to an increase in price and a breaking of a price resistance level, reaffirming the trend when analyzing this indicator. This can be measured in a variety of ways, the most common being the Volume Rate of Change and the Chaikin Oscillator. The first emphasizes increases in volume (which usually supersedes a price change), and the second evaluates the rate of money entering and exiting the market, identifying potential trends.

Chaikin Oscillator
An example of a Chaikin Oscillator on a BTC/USD price chart – tradingview.com

How Does a Technical Indicator Work?

As we established earlier, technical indicators are statistical equations created to measure and analyze trading market data. Although they all measure different aspects of the market, they work similarly to any other equation, with a mathematical formula and inputs leading to data outputs and analysis. These equations are used to try and understand the market psychologymarket sentiment, and future asset prices by analyzing price trends and trading patterns. Since technical analysis does not care about the fundamental value of the asset, technical indicators work by analyzing previous patterns.

For example, let’s look into Moving Averages. This technical indicator is specifically used to identify price resistance levels and to identify price trends. This equation is calculated by taking the average price of an asset over a specified period. The individual and varying prices would be added up and then divided by the total number of prices in the set, therefore creating a “moving average” of prices over a given period of time. When comparing this average price to the current price changes, traders base their strategy off the indication that this trend will predict the future outcome of the price and the market direction.

Why Should I Use Technical Indicators?

Technical Analysis Chart

Although past performance is no guarantee of future results, the goal of using technical indicators is to identify and create the best trading opportunities for yourself on a short term basis. If you are planning on day trading or entering/exiting a current position, technical indicators can be used to help predict trends, their strength, movement, and potential price resistance levels.

Using Technical Indicators to Develop a Strategy

Since technical indicators can be used by many different kinds of traders and for different reasons, it’s important to develop a strategy to fit your goals. Technical indicators can be used to signal a change in trend or momentum. If you once again take Moving Averages for example, once there is an intersection in the chart, it is a sign that there will be a change in the trend. If the price has been trending downward and the Moving Average is crossing over, you might want to consider liquidating that position before the price breaks a resistance point and drops further.

How Many Technical Indicators Should I Use?

Each trader has their personal preference of how many indicators they use, but generally, less is more. The number of technical indicators you use will be based on the information you see relevant to the trading situation, but sometimes too many indicators causes ‘analysis paralysis’. If you have too many unrelated data points leading you in a variety of directions, you may feel too overwhelmed to make a decision. You do not need to have 5 different Moving Averages tools to understand the trend, and may end up wasting time and overwhelming yourself on the way. If you are trying to predict volatility or momentum, you will have to use different technical tools, but in most situations try to keep it between 2-5 indicators.

Choosing Technical Indicators Once You Have Developed a Strategy

As stated above, different situations and analysis will call for different tools, so make sure you understand exactly what information you need. If you are looking for the right time to enter a new position, perhaps you will be looking for if the asset has momentum and is oversold or undersold. Additionally, you could measure its volatility and predict if this trend will continue or may switch directions. Once you have chosen your strategy, carefully analyze what indicators you’ll need to understand the previous trading patterns.

Concluding Thoughts

Depending on your outlook on technical analysis, you may find technical indicators very useful or see them as a tool that simply creates a self-fulfilling prophecy. Either way, it is important to understand why technical indicators were created, what they represent, and what exactly they’re being used for. Psychology and market movement are undeniably linked, so it is very possible that statistically analyzing these patterns could produce a favorable trading outcome. If you are interested in using technical indicators, start with basic ones, make sure you fully understand them and add 1 or 2 more indicators over time to see how your predictions pan out.

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