[Technical Indicators and How to Identify Fakeouts] - Crypto Academy / S4W4- Homework Post for @reminiscence01


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This week's lesson was on technical indicators, how to identify fakeouts while using an indicator, and when these fakeouts can be used as an indicator for a trend reversal.

Based on the trading style of an investor, there are two types of technical indicators. They are grouped depending on if they indicate price changes early or late. These are the Leading indicators and the Lagging indicators.


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Leading Indicators

Just as the name implies, leading indicators are the group of indicators that signal a change in price action before it occurs in real time. The leading indicators can be likened to prophets in a religious setting, who pass information about unknown future events to people.

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ATR signalling the start of a trend

The leading indicators help to detect when a trend is about to begin, and to an extent how long the trend would last. Leading indicators also make detection of reversals easy. All these signals are given before there's a change in the price action of the asset. This helps investors in making early decisions and minimizing their stop loss level.

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Early trend reversal signal with ATR

The main issue with the leading indicators is that they are prone to fakeouts. What do I mean? For example, a leading indicator would signal a possible change in trend which may just be a minor retracement before the continuation of the already existing trend.

Some examples of leading indicators are RSI, ATR, stochastic oscillator, etc.


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Lagging Indicators

Lagging indicators are indicators that need to wait for price movement before any signal can be given. A lagging indicator can only indicate a bullish movement when it has already started. The same goes for a bear move and trend reversal.

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Bollingner Bands giving late signals as a lagging indicator

Because the lagging indicator gives signals after a change in the price chart, it can make investors to miss out on the beginning of the trend or the best part of it. This is a major setback with these indicators. Because of this, combining the lagging indicator with a leading indicator is a very good strategy. The lagging indicator could act as a confirmation for signals given by the leading indicator.

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The shaded region shows a retracement during an upward movement in price. The retracement had occured for the most part before the indicator signalled the movement. This is a setback with the use of the lagging indicators. In this scenario, the investor would have missed out on the best part of the retracement, which could lead to bad decision making

Examples of the lagging indicators are The Bollingner Bands, Moving Averages, etc.


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Factors to Consider When Using Technical Indicators

There are so many factors to consider with the use of technical indicators. These factors would have a great influence on an investor's success rate with the use of technical indicators. A few of these factors are stated below:

Trading Strategy and Risk Management
Any good investor would know better to have a trading strategy before even venturing into the crypto market. A scalp trader would flourish best with the use of moving averages, both the simple moving averages and the exponential moving averages. Why? This is because these indicators ride the trend and are best for quick decision making. A swing trader and long term investor would make use of an indicator like the RSI. This is because the overbought and oversold signals, along with the divergence given by the RSI does not occur in multiple successions within a small time period.


Nature of Market
The market situation should also be put into consideration when using technical indicators. An investor should make use of leading indicators for a high volatility market so that price movements would be detected early. This would help in better decision making. Also, trend-based indicators should be used in a market with a defined trend. On the other hand, momentum indicators should be used for ranging markets.


Type of Indicator
No indicator can suit all market situations. As a result of this, the indicator in use should also be taken into consideration. A trend-based indicator is best for a trending market and momentum indicators for measuring how far a trend has travelled in order to determine good entry and exit strategies.


Confluence
Confluence is simply confirming the signals of a technical indicator with another indicator or trading technique. Confluence trading maximizes the profitability of a trade.

The image below is a BTCUSDT chart. The RSI indicator signalled an oversold region which signified a trend reversal. The MACD indicator is incorporated in the chart. On this indicator, it is observed that the MACD line and the signal line are still close together regardless of the oversold indicator. A great distance between the two lines indicates a strong trend movement, and this was not the case. The price observed no trend reversal as we can see in the image.

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How to Filter False Signals from an Indicator

It is a common knowledge that technical indicators are not 100% accurate. They are prone to errors when used for technical analysis.

Technical indicators can give false signals which can be disastrous to investors. In order to filter these false signals, it is necessary that every investors should look for confluence during technical analysis. Like I explained earlier, confluence is simply the combination of a technical indicator with another trading technique. Confluence is bound to improve trading experience and this increases the win rate of an investor.

Also, combining technical analysis with fundamental analysis is a sure way to filter fake signals. Fundamental analysis is the use of real-world information for price-forecast of crypto assets. The use of technical indicators can signal a strong bullish trend, but a sudden economic crisis would greatly affect the signal given by the indicators.

It is always best to confirm all signals from technical indicators for better decision making.


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Divergence

Divergence is a situation when the price chart and the technical indicator move in opposite directions. A divergence is basically when a fake out is filtered to read an accurate signal. There are two types of divergences namely; Bullish Divergence and Bearish Divergence.

Bullish Divergence

A bullish divergence is a situation when the price of an asset is going down, but the technical indicator signals an upward movement. A bullish divergence signals a market reversal that would result to a bullish movement. A bullish divergence is indicated as higher lows on the indicator and lower lows on the price chart.

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Bearish Divergence

A bearish divergence is a situation when the price of an asset is going up, but the technical indicator signals a downward movement. A bearish divergence signals a market reversal that would result to a bearish movement. A bearish divergence is indicated as lower highs on the indicator and higher highs on the price chart.

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Conclusion

Technical indicators are very useful tools in price forecast of crypto assets. The lagging and leading indicators should be used in different scenarios depending on the trading strategy of the investor.

I have handled the assignment and hereby completed the given tasks.

Special thanks to @reminiscence01


Comments 1


Hello @uchescrib, I’m glad you participated in the 4th week Season 4 of the Beginner’s class at the Steemit Crypto Academy. Your grades in this task are as follows:


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Thank you for participating in this homework task.

02.10.2021 01:27
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