Warren Buffet put it best when he dropped this famous gem: “In the business world, the rearview mirror is always clearer than the windshield.” In other words, it’s easier to look behind you and analyze what has happened than to look ahead and see the future. In the world of trading, this is certainly true of the price of bitcoin!
Was Buffet taking a defeatist stance about predicting price movement? Maybe.
That being the case, the following is also true: The best bitcoin indicators use what’s in the rearview mirror to predict what you will see in the windshield.
In this guide, you will discover five of the most popular bitcoin indicators that you can use to potentially predict future price developments.
What Are Indicators?
Indicators are tools used with technical analysis to help traders try to predict price movements. Technical analysis uses historical price data – anywhere from years to seconds-old – to provide mathematical models of price action. These models are either turned into indicators.
The data from the formulas is output into a graph, and the graph is overlaid on a chart or positioned alongside it to help traders make decisions.
Can Indicators Predict the Future?
No. However, they can help a trader observe trends and assess their strength. The logic justifying indicators follows Newtonian physics: Price moves have momentum, and the more momentum a move has, the harder it is to stop, and vice versa. This concept is summed up in the famous adage, “The trend is your friend.”
Consider an example:
If 20,000 people go buy a hot toy 21 days before Christmas, and 25,000 buy the same toy the next day, and 30,000 buy the same toy the day after that, it’s likely that at least some folks are going to buy it the next day, too. So if you own a store, and you put that toy up for sale, you’re most likely going to be able to sell it. On the other hand, if a couple weeks have gone by, and the numbers drop from 30,000 to 15,000, to 5,000, you may want to think twice before ordering more of the toy.
Indicators use formulas and graphs to help traders “see” what buyers and sellers are likely to do next.
Top Five Bitcoin Indicators
1. Ichimoku Clouds
The Ichimoku Cloud indicator is a conglomeration of five lines, and each line displays averages over time periods, the overall length of which can be determined by the trader. When two of the lines cross, the area between them is shaded in, thus forming a “cloud.”
When the price is above the cloud, the trend is up, and when the price is below the cloud, the trend is down. If the cloud itself is also moving in the direction of the price, the trend is a strong one.
2. Relative Strength Index (RSI)
RSI is one of the simplest indicators. It indicates if an asset is overbought or oversold. RSI uses historical data to try to determine the overall demand for an asset. It then calculates whether people are buying so much of the asset that there is likely going to be a downward correction in price or if the opposite is occurring, and the price is likely to rise.
The RSI indicator has two lines, one at 30 and another at 70. According to the indicator, when the reading is above 70, the price is likely to drop, and when the reading is below 30, the price is likely to rise.
3. Moving Averages (MA)
When prices spike in one direction or another, it can be easy to misinterpret these movements are reversals or continuations of a trend. A moving average indicator calculates the average price over a time frame, recalculating it as time passes.
A short-lived spike will have little effect on a moving average indicator set to a long-enough time frame. Looking at a graph depicting moving averages can be useful in determining support and resistance levels. Support is a “barrier” at a lower point through which the price is less likely to sustain a continued move. Resistance is the opposite: a level above the price through which it is unlikely to make a sustained move. With a moving average indicator, it’s easy to see these levels.
Fibonacci, like moving averages, is another useful tool when trying to predict the parameters of price action. While Fibonacci is not a set of complex, interdependent calculations like many other indicators, it still makes the list because of its usefulness. The Fibonacci ratios naturally occur in nature and in human decision-making.
When there is a sudden movement in price, it will often retrace, or make a move back, towards the trend. A lot of traders believe in the Fibonacci ratios. So, the levels are sometimes met partially because of the principle of self-fulfilling prophecy: People think it will happen, so they make it happen with how and when they decide to place their trades.
Volume is perhaps one of the most valuable, yet underrated bitcoin indicators. Volume shows how many people are buying or selling bitcoin. It’s a good idea to check volume before making a decision based on any of the other indicators. Here’s why:
If there is a significant price move in a particular direction it only has momentum if there are enough people behind it.
Think of the number of traders behind a movement in price as the “mass” in the momentum calculation of Momentum = mass x velocity. The fewer traders, the less momentum. Because less momentum also means less price “inertia,” price movements without adequate volume are more easily reversed. Going back to the toy example, if the toy usually sells for $50, but suddenly it is being sold for $100, that looks like the value of the toy has doubled. However, if only five people bought it for $100, the true value is likely still closer to $50.
- The Difference Between BID, ASK, BUY and OFFER in Bitcoin Trading
- What Is Momentum Trading, and How Does It Work with Bitcoin?
- Bitcoin Technical Indicators: How Support and Resistance Work
The best bitcoin indicators have the potential to help guide your trading decisions because what’s in the rearview mirror can sometimes help indicate what can be seen through the windshield. To get your complete bitcoin roadmap, subscribe to Bitcoin Market Journal today!