Trading Strategies and Indicators

Trading strategies and indicators

How To Use The Standard Moving Averages (SMA)
How To Use The MACD
How To Use The Bollinger Bands
How To Use The Relative Strength Index (RSI)
How To Use The Fibonacci Retracement Tool
Three Ways To Time The Market
Strategies and Reversal Patterns

How To Use The Standard Moving Averages (SMA)

The simple moving averages are one of the tools that you can use for trading or investing of (crypto) currencies. They can help well with finding support or resistance levels for certain prices as well as good buying points on pull backs.

So how can we set up the simple moving averages and use them properly while trading and investing?

First go to tradingview.com, create an account and open a chart.

Moving averages are one of the most basic tools, but very useful at the same time. They’re available in most exchanges (or on tradingview.com) you can add them in your indicators tab.

And you’re going to look for “Moving average” or “MA” (which stands for moving average). Frequently used moving averages are the 50, 100 and 200 MA’s. Go ahead and add those to your chart. You can do this by adding it 3 times. Then click on the little wrench below Bitcoin/Dollar or whatever chart you are using. And change the “Length” to 50, 100 and 200.

Your chart should now look something like this:

The chart we are looking at is a daily chart of Bitcoin/Dollar, so every candle on this chart represents 1 day.

The moving averages you added into your chart are now calculated as followed:

The “Length” you added to the moving averages means that the moving average will now calculate an average of the previous 50, 100 or 200 daily closing prices, depending on what value you assigned to its Length.

So how do we use the moving averages in trading?

The moving averages are most useful in daily-charts (but can also be used on different timeframes). If you look at the chart, you’ll probably notice that prices often bounce of these moving averages lines. In general you could say that the longer the timeframe of the moving average, the stronger the support or resistance it offers. The 50-day moving average kind of gives a sentiment of the current market. If it’s staying above this line, the market is generally confident. When it drops to the 100-day moving average there is a little more fear in the market. A drop or pullback to the 200-day moving average is something that happens over a longer timeframe and happens when the market has been overbought for a while.

How To Use The MACD

The MACD is a popular indicator and stands for moving average convergence and divergence, which means that is tracks the differences between moving average lines. It is used to notice trends before they happen.

When you add the MACD to your chart it will usually show up at the bottom of the chart. It consists of 2 lines and some pink bars.

The blue line is the 12-day exponential moving average (Blue in the chart), which is a different than the simple moving average. There’s also the orange line which is the 26-day exponential moving average.

The bars show distance between the 2 lines. When the 12-day exponential moving average (Blue) is above the 26-day (orange), the bars will go up. If the 12-day is below the 26-day the bars will go down.

The blue lines can cross the orange line upwards or downwards. In an upwards trend you want to see the blue line stay above the orange line, this shows a positive sentiment in the market. If the blue line crosses the orange line downwards you can see that the prices often move in that direction as well (see ~december 2017 in the Chart). That often means the market is in a pullback or bear-market. Which is usually a time to sell.

Around februari 2018 the blue line crossed the orange line again and the market moved up a little. A cross shows some positive sentiment in the market, but doesn’t mean you should instantly buy in. An uptrend is most clear when the blue line holds a “steady” uptrend and stays above the orange line.

When the MACD has a number value (seen on the right of the MACD in the chart) it often means the market is overbought and it can be a good idea to close some of your positions.

You want to buy when the difference between the 2 lines is high, it is likely to cross and has low momentum. The difference between the lines is shown in the bars in the MACD-indicator part of the chart.

  • Difference between the 2 lines is high (Shown by the bars in the MACD-indicator part of the chart).
  • It has crossed and the 12-day line has has stayed steadily above the 26-day line
  • It is on the lower end of the indicator chart.

How To Use The Bollinger Bands

The Bollinger Bands are commonly used in equity markets and crypto currency. It’s a useful tool if you know how to use it as it can help you to find dips to buy and overbought moments where you can consider selling your position.

The Bollinger Bands consist of 2 outer lines and a middle line, which is the 20-day moving average. The outer bands show the deviations from that 20-simple moving average. The wider the bands are, the more volatility (a lot of movement in price) there is in the market. And closer bands mean less volatility in the market.

As you can see in the chart, during May, June and July in 2017 the Bollinger bands were a lot closer and the price didn’t fluctuate nearly as much as in November/December of 2017 where the Bands were a lot wider. After there has been a period of high volatility there is often a low volatility period where there isn’t as much movement in price, so the Bollinger bands will become closer again.

So (in general) if there has been a time of low volatility (with close bands) you can expect a period of high volatility to come in. This movement could be to either side, upwards or downwards!

Overbought or oversold levels can be spotted with the Bollinger bands, this is not guaranteed. But 98 or 99% of all the volatility or price action happens within the Bollinger Bands! The outer bands take the deviation from the 20 simple moving average into account. As you can see in the chart, almost all of the price action remains within the bands, but during the big run in December 2017 you can see it went outside of the bands. This indicated overbought levels and meant a correction was likely to come, which it did. It is not recommended to buy if the price rises to above the Bollinger Bands. At the same time, it can be a good idea to buy when the price drops to below the Bollinger Bands!

Wait for the bands to narrow in, and once the volatility has lowered down. And the bands have gotten narrow against the 20 simple moving average that’s when you want to look for a breakout to the upside or downside.

How To Use The Relative Strength Index (RSI)

There are a few components to the relative strength index. There is the RSI-line and there are 2 lines at 30 and 70 levels. These indicate overbought (70) and oversold (30) levels.

If you look at the RSI-line, you will probably notice that it is quite similar to the chart you’re applying it on (in this case Bitcoin/USD). When Bitcoin gets sold, the RSI lowers as well. And usually crosses the 30 line. When it’s under 30 it’s usually an indicator that it has been oversold, although like every indicator this is no guarantee!

When it has been over the 70 level for a while, it is likely overbought. This doesn’t always mean that it is time to sell. It means that it is possibly a good idea to think of an exit-strategy as “the boat” has tipped too far to one side. Just because a cryptocurrency or asset is oversold doesn’t mean it will rise. There can be a reason that it is oversold, it could just be a bad asset/cryptocurrency.

Another way traders use the RSI is using divergence. If the price of an asset or cryptocurrency is going up or down and the RSI is trending in the opposite direction, it could indicate that there is a reversal coming.

How To Use The Fibonacci Retracement Tool

The Fibonacci Retracement tool is used to find levels where (institutional) investors will start coming in. You can apply it in your charts by finding a top and a bottom in the chart. Select the Fibonacci Retracement Tool and apply it from the top to that bottom and it will provide you with different levels (0, 0.236, 0.382, 0.5, 0.618, 0.786 and 1).

In the chart you can see that Bitcoin had an obvious top and bottom from December 2017 top around Februari 2018. There was a lot of buying volume at the bottom around $6000 during February 2018. These buyers could use the Fibonacci Retracement Tool to set price points at the different Fibonacci levels they want to sell at. The levels basically mean that if you want to reach a 38.2% return when you bought at that bottom you’ll need to reach the price point of about $11300. This means that these levels are often selling points, so resistance levels. As you can see in the chart around the 0.38 level there was a big resistance around February/March 2018.

Quite like the big even numbers, it is recommended to take profits a little earlier than exactly those levels as it will not always reach those levels. You can use these levels to take profit at these levels. For example: Sell 50% of your position at the 0.23 level, 25% of your position at 0.382 and keep 25% for higher levels if you think it is going to reach those levels.

Three Ways To Time The Market

1: Big even numbers

Big even numbers are one of easiest price strategies you can use to know when markets are overextended or oversold. For example Bitcoin’s first major bull run in 2017 ended around 3000. After that It hit 5000 in September and then dropped again. In the chart above you can see some major even numbers which acted as important support or resistance levels where people started buying or selling.

In the market people like to buy at even numbers. People set their own expectations on at what price they want to sell as part of their trading plan. Think for yourself, would you sell your Bitcoin at 5000 or at 5106? Or would you like to get in around 3000 or 3080. At even numbers there are often big spikes in either buy-orders or sell-orders. Psychology is an important aspect of trading. A good example of Psychology in the markets would be clear in: The stages of an economic bubble.

It’s generally a good idea to be a little on the safe side. For example, it would have been safer to set your target sell price at $19900 instead of $20000 during the big bull run in December 2017. If you waited till your target of $20000 you might have just missed it and would have experienced the big drop from the big even number. Ofcourse this is hindsight, but as you can see from the even numbers, often after reaching these targets big sell-offs occur.

2. Previous price points

Previous price price points. These could be the big even numbers like before. But often when an asset or cryptocurrency is moving upwards it faces resistance points. See for example when Bitcoin reached $6000 in October/November 2017. It took some “effort” to break that resistance after which it spiked up and went down again, only to find support again, and not go lower than $6000. After this it had a major run up, but it found support around $6000 again during Februari and June of 2018.

The same goes for a support being broken. After the big run up to $20000 bitcoin dropped to around $11000/$11500 in Januari 2018 where it found support for a bit before breaking this support and dropping a lot further to $6000, after which it went up again to the same $11000/$11500 zone in Februari 2018. But now this previous support had become a resistance level which it was unable to break, after which it went down again.

3: Buy when people are fearful, sell when people are greedy

If you’re looking into trading, you probably know Warren Buffet, the most successful investor of all times. One of his quotes is:

This applies to most markets, also in cryptocurrency markets. In cryptocurrency forums, chats, and new articles you will notice euphoric statements where everybody claims to be a genius for making a lot of money when the market is up during a massive run. This is usually a good indicator it’s time to sell and people are caught in a bubble (see the post about the “bubble phases”). At the same time, during a major correction (like the one bitcoin experienced after it’s run to $20000) you’ll notice people/new/media questioning whether “Bitcoin is dead?” or being in despair, which could be a good time to buy.

Strategies and Reversal Patterns

There are a lot of day trading strategies and patterns but the following ones are usually good set ups with a decent risk/reward and winning probabbility.
It is important to keep in mind that you should not use trades on charts bigger than the hourly chart, ideally you’ll be using the 15 minutes and 30 minute chars.

1. Pin Bar Setup

This is one of the most accurate and highest probability patterns that indicate a reversal in any market. The pattern indicates how the battle between buyers and sellers end up in favor of buyers or sellers. Pin bar may appear at the top or bottom; however, it is equally important when it appears within the trend. So what does a pin bar look like and how can we identify it?

Day trading Stategy: Bullish and Bearish Pin Bars

As you see in the above figure, pin bar is a candle with small body and long wick. The long wick indicates failed effort to continue the trend and beginning of a new counter trend wave. The pin bar setup must have the following conditions to be a high probability setup:
a. The back ground must have a trend based on at least 20 candles. Ranging or corrective background may not qualify for reversal.
b. The color of pin bar does not affect but the succeeding candle must break the low of pin bar and close below for bearish setup. Similarly, the succeeding candle of bullish pin bar must break the high of pin bar and close above.
Strategy
Once you find the pin bar setup, then you must devise a smart trading strategy to filter bad trades. Let’s have an example of bearish pin bar setup and how to successfully trade it.

Day trading strategy set up using a bearish pin bar
Look at the above chart of GBP/USD on hourly timeframe. The pin bar appears after bull run of 30 candles. Longer the bull run, stronger will be the reversal. After spotting the pin bar, place horizontal lines at its low and high. Call the low line “trigger line” and wait for a candle to break the trigger line and close below it. Short sell GBP/USD at the close of bearish candle as shown in the chart. Your take profit should be the next strong support level.
Now take a look at bullish pin bar setup below:
Day trading strategy set up using a Bullish pin bar

Here, we have bearish background of 21 candles and bullish candle close above the trigger line of pin bar which becomes the entry price for trade.

2. Double Top/Bottom

Double top pattern occurs at the end of a bull run market forming two peaks at approximately the same price. Similarly, double bottom pattern is formed at the end of a bearish market forming two price minima with a local peak. Take a look at figure below to understand the patterns.

Day trading double top and bottom pattern

 

 

 

 

If double top/bottom pattern is traded smartly, it can get you multiple times reward than that of risk. Once you find the double top pattern, look for the bull run background to validate the pattern. Now wait for a bearish candle to appear and close after the double top is formed. This is your point to short sell the instrument and placing the stop loss slightly above the double top. The neckline support can be your take profit level or you can move the stop loss to breakeven when price reaches neckline and then your take profit level should be the next strong support area.

Day trading strategy set up, double top pattern

3. Engulfing Pattern

This is another high probability reversal pattern based on two candle. Bearish engulfing pattern is formed at the end of rising prices as the small bullish candle is engulfed by wide spread bearish candle. Similarly, bullish engulfing pattern appears at the bottom of bearish trend when a small bearish candle is engulfed by a wide spread bullish candle. See the figure below, how engulfing pattern looks like:

Day trading candle stick strategy

Strategy
If the price is attempting the upside after the bearish engulfing pattern appears, you should wait until the price approaches high of the candle. If the price breaches high, you should stay out of trading and if the price starts rejecting from the high, then you may have an aggressive entry at the highs. Alternatively, you may enter the short trade once engulfing candle closes and the next candle is not bullish. See the chart below:

Day trading candle stick strategy set up

We enter the trade right after the engulfing candle close as weakness prevails afterwards. Stop loss is placed slightly above the high of engulfing candle while take profit is placed at the next support level.
Now take a look at the chart below to understand bullish engulfing pattern.

The bullish engulfing candle appears at the bottom followed by prevailing strength. Stop loss is placed slightly below the the low of engulfing candle while take profit level can be the recent swing high or resistance level.

It is important to keep in mind that discipline in keeping the stop and take profit should not be breached. If your trade is stopped out, never think of reentering the opposite side of trade. Rather you should wait for another appropriate pattern to appear and then trade.

Now let’s take a look at how to smartly trade double bottom. Look for the background of double bottom to validate the pattern. You may ignore the immediate background as it can be mildly ranging.

Day trading strategy set up, double bottom pattern

Wait for the bullish candle to close after the double bottom is formed. Place the long order and keep the stop loss slightly below the double bottom. Your take profit should be neckline resistance but you can ignore neckline if the entry price and neckline are too close. Then look for the next strong resistance to place take profit.