Technical Analysis Fundamentals in Algorithmic Trading

Thu Jan 19 2023

Algorithmic trading is the use of computer programs and algorithms to execute trades based on specific rules and conditions. Here, technical analysis is employed to arrive at market signals based on the conditions set.

When it comes to algorithmic trading, many of the tools that are being used in traditional trading remain relevant and in many ways algorithmic trading extends the use cases of technical analysis indicators. By allowing for a more macro approach, as well as the ability of performing this analysis on hundreds or thousands of coins.

What are Algorithmic Trading and Technical analysis?

In case you are relatively new to this algorithmic trading, also known as algo-trading, refers to the use of computer programs and algorithms to execute trades on financial markets. These algorithms are designed to analyze market data and make trades based on specific rules and conditions. The use of algorithms allows for trades to be executed at a faster pace and with greater precision than would be possible with manual trading but they include many other benefits. There are virtually no limits to the logic that trading algorithms can use and can range from Technical Analysis, to volatility and even market sentiment analysis and machine learning. Our cryptocurrency algorithmic trading platform Æsir supports many of these strategies along side other tools for building complex logic and trading algorithms.

Technical analysis is a method of evaluating one or more assets by analyzing statistics generated by market activity, such as past prices and volume. TA is often used to identify patterns that help make trading decisions. Technical Analysis and algorithmic trading have known each other for long time, however these are still relatively new tools in the realm of cryptocurrency trading.

Using Technical Analysis in Cryptocurrency Algorithmic Trading

When it comes to algorithmic trading, technical analysis can be used in a number of ways. Technical Analysis can be performed either on the price itself, take price volatility for instance. The trading strategy could be as simple as:

Buy ANY COIN on THIS EXCHANGE if the current price fluctuates by more than 3% in the last 5 minutes.

You can easily set up a strategy like this on platforms like Æsir.

Another way that technical analysis is used in algorithmic trading is through the use of indicators. We won’t go into too much detail for each specific indicator, but we will cover those in a future article, so make sure to subscribe.

From a 10,000 feet view - indicators are mathematical calculations that are based on the price and/or volume of an asset. They are often used to identify patterns or trends that may indicate a change in the direction of the security’s price. Some popular indicators used in algorithmic trading include the Moving Average, Relative Strength Index (RSI), and Bollinger Bands.

One of the key advantages of using technical analysis in algorithmic trading is that it can help traders identify patterns and trends in the market that are not immediately obvious and at a volume that would be impossible to perform manually

Computed versus Traditional Indicators

Some cryptocurrency trading platform such as Æsir, offer different ways in which these can be used as part of an algorithmic trading strategy. Computed indicators are signals that have already been calculated. They are easier to set-up and use, but offer less customization options. Take the RSI indicator for instance -

A buy signal is typically generated when the RSI falls below a certain threshold, such as 30, and then rises above it. This suggests that the asset may have been oversold and is now becoming undervalued, indicating a potential buying opportunity. A sell signal is typically generated when the RSI rises above a certain threshold, such as 70, and then falls below it. This suggests that the asset may have been overbought and is now becoming overvalued, indicating a potential selling opportunity. A computed indicator will just return the “signal” ie Buy or Sell according the RSI value. This simplifies things but doesn’t allow for the in depth customization that is possible by configuring a strategy using traditional indicators.

Traditional indicators stripped down of their “computing layer”. Adding an RSI indicator to a strategy will allow you to decide at which point you want a strategy to preform an action. This allows you to enter and exit the market at times at different times and can help you identify new patterns and strategies.

Limitations of Technical Analysis

It is important to note that technical analysis is not a perfect method, and it has its limitations. It relies on past data and may not take into account fundamental factors such as company’s financials, political events, etc. Additionally, technical analysis can be prone to misinterpretation and subjectivity, which can lead to inaccurate predictions. It is important to take some time and familiarize yourself with technical analysis if you’re new to it, and when it comes to trading (manual or not) it’s best to start with Paper trading account so you can safely put your strategies to the test without risk losing real money.