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Crypto Technical Analysis: The Importance of Stochastics and Relative Strength

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technical analysis moves

Any time fear gets out of control, pay close attention to technical analysis for direction on the next moves.

They allow you to determine when its time to be greedy when others are fearful; and fearful when others are greedy. This is according to Warren Buffet’s advice.

Technical Tool — Bollinger Bands (2,20)

Experts typically place the Bands two standard deviations above and below a moving average.

The idea behind such bands is simple.  When a stock – or cryptocurrency — touches or penetrates the lower band, the situation can be considered oversold. When a stock touches or penetrates the upper band, it can be considered overbought.

But we never want to rely on one indicator, so we confirm with others, such as RSI and W%R.

Technical Tool — Williams % Range (W%R)

When Williams moves to or above its 20-line, it’s an indication the asset is overbought.  When it moves to or below the 80-line, it’s oversold

Technical Tool — Moving average convergence-divergence (MACD)

Investors use the difference between a short-term and long-term trend and momentum behind a stock (typically a 12-day and a 26-day moving averages are used) to calculate MACD.  With MACD, when the short-term line moves above the long-term line, we can make an argument for higher moves in the stock.  We can predict a lower move when the short-term line crosses under the long-term line.  With MACD we’re simply looking for unsustainable, big moves.

However, there are others to be well aware of.

Technical Tool — Stochastic Oscillator

Stochastic is a famous technical indicator which functions as a standard range-bound oscillator for measuring the price momentum. The Stochastic oscillator (Stochs for short) compares a security’s closing price to its other wide range of prices over a specific time period. The extent to which the Stochastic oscillator is sensitive to the market movement can be reduced by two ways. One is by using the moving average of the complete result and the second is by the adjustment of a specific time period.

The Setting for Stochastic Oscillator

The stochastics are functional in both range as well as trading markets. The main task with stochastics is the right interpretation of the readings present between 0 to 100.

The components of Stochastic oscillator are as follows:

It comprises of a first line, namely %K. It finds its use in displaying the currently showing closing prices as compared against the specific low and high period. There is a second line, namely the % D that represents a simple moving average (SMA) of the value of %K. For stochastic oscillator, the most commonly applied setting is 14,3,3 or in simple terms 14,3.

This notation simply points to two things

  1. i) 14-period look back
  2. ii) A 3-period % D (which is the SMA for %K)

The Formula for Stochastic Oscillator

As seen from the above setting for the calculation of the stochastic oscillator, the following formula should be used:

%K = 100(C – L14)/(H14 – L14)

%K=  The currency pair’s current market rate

C = The latest closing price

L14 = The low price traded during the previous 14-day period of trading sessions

H14 = The Highest price of the same previous 14-day trading sessions

%D = A 3-period simple moving average (SMA) of %K

The standard general theory which serves as the foundation for this stochastic indicator is that the price will be closing in the vicinity of the high point in a market which trends upwards. Similarly, in a market which trends downwards, the price will be closing near the low point.

Technical Tool — Relative Strength Index (RSI)

We can use RSI to confirm other indicators. Typically, when RSI moves to or above the 70-line, we have an overbought condition. When RSI moves to or below the 30-line, we have an oversold condition.  It finds its use in measuring the value of the recent changes in price. Its main purpose is the identification of oversold and overbought conditions that are present during an asset trade.

The formula for Relative Strength index

The following formula is useful in the calculation of the Relative Strength index (RSI):

RSI = 100 – 100 / (1 + RS)

RS = The mean gain of the up-periods that happened during a specific time frame / the mean loss of the down-periods that happened during a specific time frame.

Using RSI, it becomes possible to evaluate the strength of the recent price performance of a security, thus, making it an effective momentum indicator. The values of RSI range from 0 to 100. There is a default time period for the comparison of the up-periods to the down-periods, which is 14. It means it is a norm to consider the value of RSI over 14 trading days.

Tips for the use of RSI Indicator

Unexpected huge price movements are capable of creating false sell or buy signals within the RSI. Therefore, the best way for using it is to apply refinements on it or use it in conjunction with other affirming technical indicators. There is also a practice popular among many traders who wish to avoid the false signals of the RSI. Their common approach is to use extreme values of RSI as sell or buy signals. These common extreme RSI readings show two probable values. It is either a value of above 80 ( indicating overbought conditions) or a value of below 20 ( indicating oversold conditions).

The use of trendlines in conjunction with RSI is another common practice. It is because trendline resistance or support often shows an alignment with the resistance or support levels in the readings of the RSI.

Difference between Stochastic Oscillator and Relative Strength Index

Both the Stochastic oscillator and RSI(Relative Strength Index) are price momentum indicators useful in forecasting the market trends. In Spite of fulfilling the same goal, both of them display different methods, theories and applications.

RSI keeps track of the  oversold and overbought levels through the measurements of the speed of the price movements.

In a general sense, the stochastic oscillator shows greater use in choppy or sideways market,  whereas the RSI shows greater use in trending markets. RSI works best when there price movements display speed, whereas stochastic oscillator works best when the trading ranges are consistent.


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