Simple Technical Analysis

The following details 6 basic, high quality indicators easy to develop a deep understanding of in a short period of time:

The indicators discussed here include:

• Exponential Moving Average (EMA)

• The Ichimoku Cloud

• Relative Strength Index

• Fibonacci Sequences

• Open Interest (market sentiment indicator)

• Funding (market sentiment indicator)

Exponential Moving Average

An exponential moving average is a technical indicator that provides several key insights for traders and analysts:

• Trend Direction: EMA helps identify the overall trend direction of an asset’s price. A rising EMA suggests an uptrend, while a falling EMA indicates a downtrend.

• Recent Price Emphasis/Volatility: Unlike simple moving averages, the EMA places more weight on recent price data, making it more responsive to current market conditions and price changes.

  In volatile markets, the EMA adapts more quickly to price changes, providing a more sensitive measure of market movements compared to simple moving averages

• Support and Resistance Levels: The EMA can act as dynamic support in an uptrend or resistance in a downtrend. Traders often look to buy when prices dip near a rising EMA (support) or sell when prices rally towards a falling EMA (resistance).

  Consider overall market conditions to solidify whether EMA should act as support or resistance.

• Potential Trend Reversal: When the price crosses above or below the EMA, it may signal a potential trend reversal or change in momentum.

  Consider overall market conditions to solidify whether EMA should act as support or resistance.

• Trade Signals: Traders use EMAs to generate buy and sell signals, often based on crossovers between shorter-term and longer-term EMAs.

• Price Momentum: The EMA’s responsiveness to recent price changes can help traders gauge the strength and momentum of price movements.

  The angle and direction of the EMA can provide insights into the strength of price momentum. A steeper angle generally indicates stronger momentum, while a flattening EMA may suggest weakening momentum.

How to decide which EMA timeframe to view?

When deciding on the timeframe to view, traders consider several factors:

• Trading Style: Short-term traders like day traders may prefer shorter timeframes (e.g., 10-day, 20-day EMAs), while longer-term investors might use longer periods (e.g., 50-day, 200-day EMAs).

• Asset Characteristics: Different assets may require different timeframes based on their typical trading patterns and volatility.

  • Volatility - Highly volatile assets often benefit from shorter EMAs. These assets experience rapid price fluctuations, and shorter timeframes can better capture movements and provide timely signals for traders

  • Liquidity - Highly liquid assets, such as major forex pairs or large cap stocks/cryptos may be more suitable for shorter EMAs. The high trading volume and frequent price updates allow shorter EMAs to react quickly to market changes.

  • Trading Volume - Assets with consistently high trading volumes tend to have more reliable short-term price movements. Shorter EMAs can effectively capture these trends, making them useful for active traders.

  • Market Capitalization - Small-cap stocks/cryptocurrencies often experience more rapid price changes compared to large-cap stocks. Shorter EMAs may be more appropriate for these assets.

  • Sector Characteristics - Some sectors, like technology, biotech, or cryptocurrencies are known for their rapid developments and news-driven price movements. Shorter EMAs can help traders stay responsive to quick changes.

  • Economic Sensitivity - Assets that are highly sensitive to economic news or reports (e.g., certain commodities, currency pairs, or cryptocurrencies) may benefit from shorter EMAs to capture immediate market reactions.

Notes on Simple Moving Average (SMA)

Investors typically choose between SMA and EMA based on their trading strategy, time horizon, and the specific characteristics of the asset they’re analyzing.

Simple Moving Average

• Long-Term Trend Analysis - SMA preferred for identifying long-term trends due to its smoother nature and reduced sensitivity to short-term price fluctuations.

• Avoiding False Signals - SMAs slower response to price changes can help filter out market noise and reduce the likelihood of false breakouts or trend reversals.

• Support and Resistance Levels - Long-term SMAs (e.g., 50-day, 200-day) are commonly used to identify key support and resistance levels in the market.

• Less Volatile Assets - SMA works well for assets with steadier price movements and less volatility.

Crossovers of EMAs and SMAs

Both EMAs and SMAs are lagging indicators. Investors consider this lag when making decisions, understanding that crossovers confirm trends rather than predict them.

Investors are cautious of false signals, especially in range-bound markets where crossovers may occur frequently without establishing a clear trend.

Traders often look at overall market conditions and for increased trading volume during crossovers to confirm the strength of the signal.

Trend Direction

• When a shorter-term moving average crosses above a longer-term moving average, it’s considered a bullish signal known as a golden cross.

• When a shorter-term moving average crosses below a longer-term moving average, it’s considered a bearish signal known as a death cross.

Ichimoku Indicator (Ichimoku Cloud)

Conversion Line (Tenkan-sen)

• Serves as a short-term indicator of market trend.

• Averages the highest and lowest price of the asset over the past 9 periods.

• Acts as support/resistance level and can signal potential reversals.

• Used to gauge short-term momentum.

Base Line (Kijun-sen)

• Serves as mid-term indicator of market trend and momentum.

• Plots the average of the highs and lows over the last 26 periods.

• Acts as significant support/resistance level.

Leading Span A (Senkou Span A)

• Calculated by averaging the Conversion Line and Base Line, then projecting it 26 periods ahead.

• Helps identify future support and resistance zones.

• Forms one edge of the Ichimoku cloud.

Leading Span B (Senkou Span B)

• Calculated by averaging the highest high and lowest low over the past 52 periods, projected 26 periods ahead.

• Also helps identify future support and resistance levels

• Forms the other edge of the Ichimoku cloud.

Ichimoku Cloud

• Formed by the area between Leading Span A and Leading Span B.

• When Leading Span A crosses above Leading Span B, this marks a potential buy signal and the ichimoku cloud will be shaded green indicating a bullish trend.

• When Leading Span B crosses above Leading Span A, this marks a potential sell signal and the Ichimoku cloud will be shaded red indicating a bearish trend.

• The cloud’s thickness and direction indicates trend strength and levels of support/resistance

  • Thin cloud = weak trend with little support/resistance.

  • Thick cloud = strong trend with strong support/resistance.

• When price action is occuring within the cloud, it is generally advised not to take a position

• The longer the price stays below or above the cloud the stronger the trend is and the more support the cloud will provide.

• The cloud projects itself into the future and can act as a leading indicator.

Lagging Span (Chikou Span)

• Represents the current closing price plotted 26 periods behind on the chart.

• Whenever the price is trading below the lagging span it indicates a bullish trend.

• Whenever the price is trading above the lagging span it indicates a bearish trend.

Entering Positions Using the Ichimoku Cloud

Buy Signal Example

In the chart below, you see the price action cross above the Base Line while the Ichimoku cloud is green, indicating a strong buy signal.

Sell Signal Examples

In the chart below, we see the price has crossed below the baseline, however the cloud is green which doesn’t give us confidence that this is a sell signal/short entry position.

In the chart below, we see the price dips below the Base Line while the Ichimoku cloud has turned red, indicating a strong sell signal/short entry.

These signals can be used with the other trend line signals described above, which makes the Ichimoku indicator unique because it has built in components to verify and validate its own signals.

Top 5 simple long entry signals

• Price above cloud

• Bullish cloud

• Bullish TK cross

• Lagging signal above cloud and price

Logarithmic Ichimoku Indicator

The Log Ichimoku indicator is a variation of the regular Ichimoku indicator. It uses logarithmic scaling instead of linear scaling to calculate the cloud and the lines. This means that the Log Ichimoku indicator is more sensitive to price movements, particularly in markets with large price ranges. The Log Ichimoku indicator is useful for analyzing markets with high volatility or large price movements, as it can help highlight trends and support/resistance levels more effectively

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a popular momentum oscillator used by investors and traders to measure the speed and change of price movements.

Key Aspects of the RSI

• Scale: RSI is plotted on a scale from 0-100

• Calculation: It compares the magnitude of recent gains to recent losses to determine overbought and oversold conditions.

• Default period: Typically calculated using 14 periods, though this can be adjusted.

• Overbought/oversold levels: Traditionally, RSI values above 70 indicate overbought conditions, while values below 30 indicate oversold conditions.

How Investors use RSI to Make Decisions

• Identifying overbought/oversold conditions

  • RSI > 70 may signal a potential sell opportunity as the asset could be overvalued.

  • RSI < 30 may indicate a potential buy opportunity as the asset could be undervalued.

• Trend confirmation

  • In uptrends, RSI tends to stay above 30 and often reaches 70+.

  • In downtrends, RSI typically remains below 70 and often drops below 30

• Divergences

  • Bullish divergence: When price makes a lower low but RSI makes a higher low, this potentially signals an upcoming upward reversal.

  • Bearish divergence: When price makes a higher high but RSI makes a lower high, possibly indicating an impending downward reversal.

• Failure Swings

  • Bullish failure swing occurs during a downtrend and indicates a potential reversal to an uptrend.

    Signaled when RSI falls below 30, bounces above 30, pulls back, holds above 30, then breaks its prior high.

  • Bearish failure swing occurs during an uptrend and indicates a potential reversal to a downtrend.

    Signaled when RSI rises above 70, drops below 70, bounces, stays below 70, then breaks its prior low.

• Support and Resistance Levels

  • Investors can look for RSI to form chart patterns like double tops or bottoms, which can be used to identify potential reversals.

• Centerline Crossovers

  • Crossing above 50 can signal rising momentum while crossing below 50 may signal falling momentum.

• Other Important Considerations

  • RSI can generate false signals, especially in strong trends.

  • RSI can be applied to various timeframes, from intraday to weekly charts.

  • Some assets may have typical RSI ranges that differ from the standard 30/70 levels, for example, at the time of writing this, cryptocurrency and AI cycles often cross above 70 RSI levels during strong uptrends.

  • RSI is generally more effective in ranging markets rather than when strong trends are occurring.

Fibonacci Sequences

Fibonacci sequences play an important role in trading by helping traders identify potential support and resistance levels, as well as entry and exit points. Traders often use Fibonacci levels in conjunction with other technical indicators or chart patterns to confirm trading signals and increase confidence in their decisions. Here’s how traders use Fibonacci tools and why they’re considered valuable:

Identifying Key Price Levels

Predicting Retracements

Fibonacci retracement levels are used to identify support and resistance areas where price may reverse or pause. During trends prices often retrace a portion of the previous move before continuing. Fibonacci levels help estimate where these retracements may end, allowing traders to plan entries in the direction of the overall trend

Typical Fibonacci retracement levels: 23.6%, 38.2%, 50%, 61.8%, and 78.6%.

Setting Price Targets

Fibonacci extension levels are used to project potential price targets beyond the previous high or low. This helps traders set profit targets.

Typical Fibonacci extension levels: 23.6%, 38.2%, 50%, 61.8%, 78.6%, 100% (not a traditional fibonacci level, but helpful), 127.2%, 161.8%, 200% (not a traditional fibonacci level, but helpful), and 261.8%

Open Interest

Open interest is a key metric in options and futures trading that represents the total number of outstanding contracts that have not yet been settled. It provides insights into market sentiment, liquidity, and potential price movements.

Definition and Calculation

Open Interest is the number of active positions in a specific contract that have not been closed, expired, or exercised.

It is calculated by adding new positions and subtracting closed positions each day. For example, if the open interest at the start of the day is 0, and 10 new contracts are bought, the open interest increases to 10. If, on the following day, five contracts are closed and 10 new ones are opened, the open interest increases by five to a total of 15.

Importance in Trading

Market Sentiment and Liquidity

• Open interest is a barometer of market sentiment and liquidity.

• High open interest indicates a high level of trader engagement and liquidity, making it easier to enter or exit positions at desired prices.

• Conversely, low open interest suggests lower liquidity and potentially higher trading costs due to wider bid-ask spreads.

Trend Confirmation

• Open interest is often used in conjunction with trading volume to confirm trends.

• Rising open interest along with increasing volume typically indicates a strong trend, as new money is entering the market to support the trend.

• Conversely, declining open interest with decreasing volume suggests a weakening trend.

Identifying Support and Resistance Levels

• High open interest at specific strike prices can act as support or resistance levels.

• These levels help traders anticipate potential price movements as the expiration date approaches.

Funding Rates.

Funding rates are a key mechanism in perpetual futures trading that help align the futures contract price with the spot price of the underlying asset. Here’s how they work and how investors use them:

When paired with open interest data, funding rates provide insight into current market sentiment.

Purpose of Funding Rates

Funding rates ensure that perpetual futures contracts (which have no expiry date) stay close to the spot price of the underlying asset. They act as a balancing mechanism between long and short positions.

How Funding Rates Work

• When the funding rate is positive, traders holding long positions pay those holding short positions.

• When the funding rate is negative, short position holders pay long position holders.

• These payments occur periodically, often every 8 hours, though some exchanges update rates more frequently.

Market Sentiment Indicator

• Positive funding rates generally indicate bullish sentiment, as traders are willing to pay to maintain long positions.

• Negative funding rates suggest bearish sentiment as traders are paying to hold short positions.

• Extreme funding rates (e.g., over 100% annualized) can signal unsustainable market conditions and potential volatility.

Trading Strategies

Investors use funding rates to inform their trading decisions in several ways:

• Sentiment analysis - High positive rates may indicate an overbought market, while high negative rates could suggest an oversold market.

• Arbitrage opportunities - When funding rates are extremely high or low, traders may engage in arbitrage by taking opposing positions in the perpetual and spot markets and collecting payments.

• Cost management - Traders consider funding rates when calculating the total cost of holding a position, as high rates can impact profitability.

• Market timing - Persistent extreme funding rates might signal potential price corrections, helping traders time their entries and exits.

• Risk assessment - High funding rates can indicate over-leveraged markets, prompting cautious traders to reduce exposure.