The Best Technical Indicators for Crypto and Stocks (part3)

Moving Average Convergence-Divergence Indicator (MACD)

Developed in the 1970s, the MACD is a momentum-based technical indicator used by a large portion of the trading population. By showing the relation between two moving averages of an asset’s price, it reflects the momentum of trends. MACD has three main components, i.e.

• MACD = 12-period EMA - 26-period EMA
• Signal Line = A 9-period EMA of the MACD.
• MACD Histogram = MACD - Signal Line

Note EMA - Exponential Moving Average i.e. a moving average type that prioritizes the most recent data points.
MACD is dependent on moving averages i.e. past prices which means the indicator is lagging. However, given its strong fundamentals, the accuracy of the MACD indicator is high and reliable.
General interpretations of the MACD indicator are as follows:

• Positive MACD = Increasing momentum of an uptrend (price rise),
• Negative MACD = Increasing momentum of a downtrend (price fall),
• If the MACD increases and crosses above the Signal Line, it is a bullish crossover,
• If the MACD falls below the Signal Line, it is a bearish crossover.

By coupling trend and momentum, MACD has evolved into a popular, yet reliable trading indicator. Also, it provides enough flexibility because MACD can be applied to price charts of different time frames.
Example 1

In the below chart, we make two observations,

• Crossover 1 (left) i.e. when MACD turns up from below 0, cutting the Signal Line, there exists a strong bullish sentiment.
• Crossover 2 (right) i.e. when Signal Line falls from the near top, cutting the MACD from below, the market is bearish on the Apple stock.

Example 2

This is another observation with regards to how MACD can be used to identify divergences and reversals. Here, Apple’s stock price hit new highs in relation to the MACD hitting a lower high. This is an indicator of trend reversal and when MACD fell below the Signal Line, the bearish divergence set in and the price fell by a substantial margin.
Now, the crossover line (black dotted line - vertical) would have been an ideal time to place short trades.

Relative Strength Index (RSI)

RSI is a momentum indicator/oscillator which measures the speed and change of an asset’s price movements. RSI values can read anywhere between 0 and 100. It is popularly used to evaluate an asset based on it being overbought or oversold.

How to Calculate RSI?

RS = Average Gain / Average Loss
This is the simple calculation of RSI. However, there are several iterations of the indicator. Rather, use TradingView and its in-built RSI indicator to ease your trading process.
Traditionally, RSI values are interpreted as follows:

• If RSI > 70, then the asset is overvalued and open for a market correction or trend reversal.
• If RSI < 30, it is an indication that the asset is undervalued.
• As RSI rises above the horizontal 30 reference level, bullish sentiments are identified.
• Similarly, when RSI falls below the horizontal 70 reference level, it is a bearish sign.

Example 1

Example 2

Stochastic Oscillator

The final trading indicator on the list is a momentum indicator called Stochastic Oscillator. It was developed to follow the momentum or speed of the price. This was derived from an accepted rule i.e. momentum changes direction before price.
This indicator oscillates between the range of 0 to 100, measuring the momentum of the asset. With regards to the timeframe, 14-period is the general rule which can be 14 days, weeks, or even months depending on the analyst’s goal.

How to Calculate Stochastic Oscillator?

The formula to construct a Stochastic Oscillator is as follows:
%K = (Current Close - Lowest Low)/(Highest High - Lowest Low) * 100
%D = 3-day SMA of %K — This acts as a Signal/Trigger Line
Lowest Low = lowest low for the timeframe
Highest High = highest high for the timeframe
%K is multiplied by 100 to move the decimal point two places

How to Use the Stochastic Oscillator?

• If the readings are below 20, then the asset’s current price is understood to be nearing its low in that specific timeframe
• Likewise, if the readings are above 80, then the asset is nearing its highest price in that timeframe
• Similar to RSI, a reading > 80 is the accepted overbought limit - sell signal
• And a reading < 20 is the accepted oversold limit - buy signal.

The Stochastic Oscillator as a sole indicator is not advisable. So, using it in combination with a moving average indicator is recommended to build a holistic trading strategy.
Example

Conclusion

This article is aimed at imparting knowledge about technical analysis, trading indicators, and their importance. Also, we delved into the know-hows and employment of seven top trading indicators. Understanding the trading indicators, their utility, and limitations is required before employing any. Coupling this knowledge with your risk appetite and time in hand is necessary to become a successful trader.