July 5, 2024 Welcome back to our series of guides about technical analysis, where we methodically try to build your expertise by using the most relevant technical indicators for day-trading cryptocurrencies.
In the first part of our overview, we learned one of the most elementary parts of technical analysis—moving averages (MA). We reviewed the different kinds of MAs (volume-weighted, moving average, and exponential moving average) and how to establish entry points, exit points, and support and resistance levels using them.
In this post, we’ll continue on our quest to master the realm of technical analysis. After learning the basics in part one, we’ll delve into some more advanced concepts of technical analysis that could help you take your trading strategies to the next level.
Before we move forward, some of the knowledge we’ll share in this blog post might be overwhelming without any former knowledge, so we highly recommend readers go through part one on the subject, as well as other related articles, to make sure they sufficiently understand the different topics presented in it. It is required for this article since we’ll be building on top of the concepts we’ve covered in the past.
In addition, similar to all of our blog posts, but especially for those including practical applications such as this, please keep in mind that all the information in this blog is solely for educational purposes and shouldn’t be considered any form of financial advice. Trading cryptos is complex, and while technical indicators can be helpful tools, they are not bulletproof. Consider your risk tolerance, financial situation, and trading goals before making any kind of financial decision, and above all, trade responsibly.
The moving average convergence/divergence, or MACD in short, is one of the most popular technical indicators. Traders use it to identify entry and exit points for trades by measuring price and momentum trends in the market.
Developed by Gerald Appel in the late 1970s, the MACD is considered one of the most reliable indicators in technical analysis. This is because it’s not just one data point but a combination of two different measurements.
To truly understand what we mean by that, let’s examine how the MACD is calculated and what it can signify for traders.
As mentioned, the MACD is designed to inform us about current market conditions through the relationship between two statistics. Although most technical analysis platforms automatically calculate this, it’s recommended that we understand the logic behind it.
The first statistic is the MACD line. The classic formula for calculating this line is subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. In other words, the MACD Line = 12 days EMA—26 days EMA.
The second statistic is the signal line. It is simply the 9-day EMA of the MACD line.
In a professional jargon, this is how this set-up is written – MACD (12,26,9)
Although the MACD can be interpreted in many different ways, the two most straightforward methods are identifying crossovers or divergences.
Crossovers: Similar to the cases of the golden cross and death cross indicators we’ve covered in the past, a crossover refers to occasions when one line crosses another line, either upward or downward.
Concerning the MACD indicator, when the MACD line rises above the signal line, it is considered a bullish signal that signifies that positive momentum is underway.
In practice, it’s an excellent time to consider entering a long position or closing any open short positions.
On the contrary, when the MACD line falls below the signal line, this crossover counts as a bearish signal, meaning negative momentum is about to start or just started.
This tells traders to consider the potential of entering a short position or closing their long positions.
Divergence: Divergence in the context of the MACD refers to times when the price of the traded asset reaches new highs or lows, while the MACD indicator does not.
In other words, this lack of coordination, or miss-match, between the behaviors of the price action in the market and the MACD can help traders evaluate current market conditions and decide their next move.
Like many other technical indicators, MACD divergence can be bullish or bearish, depending on the circumstances.
A bullish divergence occurs when the MACD creates at least two rising lows while the actual crypto price creates new lower lows. Depending on market conditions, it can signify the continuation of an ongoing positive trend or the reversal point of a negative trend.
A bearish divergence happens when the MACD forms a series of at least falling highs while actual prices set corresponding new highs. Like before, it can either alert traders that the current bearish trend is expected to continue or that bullish momentum is weakening and about to die out.
The relative strength index, or RSI, is another of the most famous indicators in technical analysis.
The primary purpose of the RSI is to measure the momentum and strength of price movements in the market. This enables traders to identify oversold and overbought territories, producing buy and sell signals.
RSI values are presented on a scale ranging from 0 to 100, where zero represents extreme oversold conditions, and 100 stands for extreme overbought conditions.
Similar to most of the other technical analysis concepts we’ve covered in the past, the RSI is determined automatically by most technical analysis platforms, and there is no need to calculate it manually. That said, we’ll go through the basics of the RSI calculation in general terms for educational purposes.
Without going into much detail, the idea behind the RSI is to compare the strength of price movements on days when prices go up to the strength of price movements on days when prices go down.
Traditionally, the timeframe under examination is 14 days.
This means we can expect higher RSI values as the number and size of up days grow and, conversely, lower RSI values as the number and size of down days increase.
As a momentum oscillator (i.e., a technical index that ranges between distinct high and low bands), the RSI is usually presented as a line graph with predefined levels for oversold and overbought conditions.
Traditionally, a value under 30 indicates an asset is undervalued. This reading alerts traders to consider entering a long position or closing their short positions.
Conversely, a reading above 70 indicates an asset is overvalued. This reading alerts traders to consider closing their long positions or opening a short trade.
While the classic versions of the MACD (12,26,9) and RSI (14,70,30) are two of the most renowned technical indicators, it doesn’t mean traders should stick with the traditional settings at all costs.
In other words, traders should remember that no indicator is accurate 100% of the time, and it’s very likely that certain variations of these indicators might produce better results than the original ones, especially when focusing on fast-paced trades with relatively short timeframes.
Regarding the MACD, traders shouldn’t be afraid to explore other less orthodox settings. For example, try using shorter EMAs or different moving averages, like the simple moving average (SMA) or the volume-weighted moving average (VWMA) we covered in our previous post.
Our outlook regarding the RSI is quite similar. A different length of RSI, with or without different marks for overbought and oversold conditions, could make this indicator more accurate for the specific crypto you wish to trade.
That said, it is essential not to rely on only one data point. The true power of these indicators, and technical analysis in general, is to combine a few indicators that can give us a more comprehensive view of the market and produce more accurate and reliable trading signals.
The MACD and RSI can achieve this relatively simply, so we presented the two indicators together.
For example, a MACD buy signal is generally more reliable if supported by an RSI reading of below 30, and vice versa. A MACD sell signal with an RSI reading of over 70 is considered more accurate than a not double-checked signal.
This logic can also be applied to alerts derived from a divergence of the MACD. While being a useful indicator, if a similar pattern also appears in the RSI graph, it can give us traders extra validation that the signal is accurate and not just a false alarm.
These common scenarios are only a few examples (of many) of how combining a couple of indicators can be more reliable than each one standing alone.
In this second post of our series about advanced trading strategies based on technical analysis, we’ve covered two of the most famous technical indicators, the MACD and the RSI.
Building on our first post, where we covered moving averages and some trading strategies based on them, we’re slowly expanding the concept of a diversified portfolio. It consists of tools that can help you boost your trading skills and strategies as promised, from zero to hero when standing alone or utilized collectively.
Nothing is bulletproof in the world of crypto trading, but with the right knowledge and proper tools, consistent profits can be achieved without taking unnecessary risks.
There is no way around it. The more you know, the better you become.
Stay tuned for our next blog post of the series, where we’ll continue to delve into the world of technical analysis and expand the toolkit for achieving consistent and successful trading.
