The cryptocurrency trading is an even more complex environment. It is definitely not for the weak hearted. If the traders are to survive and make profits from crypto trading, then they need to create a powerful algorithm or trading strategy that they can use to predict the behavior of the markets.
And there are mainly two ways of doing it. One methodology makes use of the Price Action strategy and the other makes use of market indicators. Let’s find out everything about them and which of them is best suited for bitcoin trading.
What are Market Indicators?
Market indicators, also known as technical indicators, are statistical or mathematical formulae. They are derived using the past price data of the bitcoin.
There are an endless number of market indicators. Many traders often make use of a large number of market indicators, sometimes running to dozens or even hundreds in numbers, to try and predict the market. Seasoned traders even try to come up with their own metrics by combining two or more market indicators.
To put it in simple terms, market indicators work as mini programs that can be used to predict the behavior of bitcoin. Although they are mathematical entities, they can also be plotted on a graph to give the traders a better idea and an intuitive feel about the behavior of the bitcoin markets. If there are trends in the market, then it is easier to see it on the graph than in a page full of numbers.
What is Price Action strategy?
Price action strategy involves analyzing the market’s performance in the recent past, and allows the trader to make subjective decisions based on their analysis of various external factors that are affecting the markets. The external factors can be political, economic, sentimental, or something else.
The idea is that the trader takes into account the recent price changes, but does not base their decision on it alone. They will also take into account many other factors that cannot be or are too difficult to be reduced into a mathematical form.
The Price Action strategy relies heavily on the graphical representation of the price fluctuations of bitcoin. But, it needs technical analysis too. So, in a way, depending on the price action method employed by a trader, they could inadvertently be using at least some of the market indicators as part of their strategy.
But, the most important aspect of price action is the subjectivity of the trader. No two traders come up with the same price action strategy. For the same market behavior, two traders following different price action strategies might react quite contrarily.
Which Is Better?
Although price action and market indicators are related to each other, they offer a vastly different kind of information to the traders. They both come with their own set of benefits and limitations. However, depending on what signs that trader is looking for, one strategy could be more suitable than the other. Let’s check out how the two strategies fare on different aspects of trading.
Market indicators are completely focused on the past data. They use it to smoothen out the price fluctuations and chart out the behavior of the market in the immediate future. Their limitation is that they always make use of the past information.
Any emerging trends on account of new external factors are completely ignored by almost all of these indicators. Some of them, such as MACD, do a good job of even taking the most recent price data, but it still is a far cry from what day traders like to have. To put it in perspective, market indicators almost always make use of data that is slightly, but not completely outdated. Naturally, its accuracy is highly questionable.
Price action, on the other hand, makes use of the past data as well as the most recent available information to arrive at useful predictions. So, it is a better reflection of the latest trends and moods emerging in the bitcoin market.
Amount of Information
Market indicators and price action methodologies provide a varying degree of information to the traders. At its core, a market indicator is a mathematical representation of the price behavior. This representation is highly oversimplified. In other words, a large part of the information has been sacrificed in favor of reducing the price behavior to a more actionable form.
Imagine it like this. There are countless factors that affect the bitcoin’s price at any given moment. If bitcoin is a ball, then it is being pulled in every direction. In whichever direction the force is maximum, the price moves in that direction. So, there are an endless number of forces pulling at bitcoin’s price in a 3D space. But, we need price charts to show us whether the price is going up or down.
So, we have to reduce the 3D information about bitcoin’s price fluctuations to an easily understandable 2D form. It is akin to capture a selfie of yourself. You have a 2D image, but there is a lot of info that the selfie completely missed about the 3D object that is you – your back, the color of shoes you are wearing, etc. That’s exactly what happens to the market indicators. They only capture a small amount of information.
Price action, to their credit, carry a much larger amount of information. They are able to capture some of the data that is not available in the market indicators. For instance, a typical price action methodology makes use of candlesticks charts. These charts provide information about the behavior of the bitcoin’s prices throughout the day.
On the contrary, the market indicators like Simple Moving Average only take into consideration the closing prices on each day of the specific period. So, the price action methodology is able to preserve the information about the price fluctuations throughout the day. In other words, price action provides a significantly more information than the market indicators.
We already saw that price action methodologies provide more information than the market indicators. But, is that information useful, worthwhile, or just noise?
Honestly speaking, much of what happens in the bitcoin market is pure noise. It is rational to think that the availability of more information can help us make better decisions. However, when there is too much information, it can cause analysis paralysis.
The actionable intelligence is lost under the mountains of data and it becomes a herculean task to separate the useful information from the noise. So, the market indicators behave like filtering systems that get rid of the bulk of the noise and present the trader a large part of the useful data. Although some useful data too may be lost, it is a tradeoff that the trader makes to shave off the noise.
So does that mean market indicators are better for trading?
Well, not really. Market indicators are more suitable in situations when the noise in the data increases to inordinate levels, such as in shorter time frames. If the period under consideration is a short one, like a day or a few days, then a large part of the market behavior is caused by the noise.
So, using price action to determine the direction of the bitcoin price using such short term data can be disastrous. On the other hand, market indicators make an excellent choice for the task.
Similarly, if the analysis is being conducted over a longer period, like a few weeks to even months, then the price action methodology is best suited for it. It captures much larger amount of information about the market dynamics, ultimately providing the trader a bigger perspective about the price fluctuations.
In these cases, the market indicators may oversimply the long term data and smoothen curves at the cost of vital information.
There is no one-size-fits-all solution when it comes to choosing between market indicators and price action methodologies. The truth is that price action strategy requires a great degree of subjectivity on the part of the trader, which means that the trader has to be familiar with the market for years.
They should have an intuitive understanding of what affects the market, how, when, and for how long. Only then, they will be able to make sense of the price action data to make smart decisions. Therefore, they are best suited for seasoned bitcoin traders.
Market indicators are easy to understand and even a beginner bitcoin trader can start using them after conducting a little bit of research on them. They require no subjective understanding of the markets on part of the trader, and provide clear, actionable signals on when to buy and when to sell.
Furthermore, once you gain a deep understanding of the bitcoin markets, make sure that you create your own trading strategy that employs both price action and market indicators. For instance, for short term trading, market indicators are a better option, while price action provides more useful information for long term trades.