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Technical indicators are widely used by traders to predict the future price movement of financial instruments. Amid the uncertainty in Bitcoin’s price, there’s a lot of talk about the Gaussian Channel, and the ability of this indicator to predict future outcomes.
If you're HODLing Bitcoin or other financial instruments, this article can help you decide whether to hold these assets or change your strategy. We'll also discuss relevant strategies that both long-term and swing traders can use to benefit from the existing price action.
The Gaussian channel indicator is a technical indicator which defines price trends in the financial markets by minimizing the lag.
The indicator is attributed to Carl Friedrich Gauss, one of the greatest mathematicians of all time. While Gauss did not have access to modern statistical software, nor did he intend to trade commodities, his statistical models have proved extremely powerful in interpreting price movements in financial markets.
The modern interpretation of the Gaussian channel indicator is based on the popular statistical concepts of normal distribution and bell curve. In technical terms, the normal distribution of data puts the mean in the center, and the standard deviations measure dispersion around the mean.
In simple words, the Gaussian channel indicator tries to predict the direction of a price trend, which can be used to trade forex, stocks, commodities and other financial instruments.
In trading software, an indicator is a channel that consists of three bands: A high band, a center band and a low band. Whenever the price enters the channel from either the top or the bottom, it signals a potential price reversal. The change of colors from red to green (or green to red) confirms the change.
Lately, the Gaussian channel indicator is gaining a lot of attention. It's in the news because crypto investors want to know if Bitcoin’s price will continue to decline further, or if it will bounce back.
If the price trend on the Gaussian channel is any indication, the weekly and daily charts of BTC/USD suggest that we may see a bearish run in the coming months. We can easily evaluate with a glance at the weekly BTC/USD chart.
If everything else remains constant, investors looking to HODL Bitcoin should reconsider their decision. If they're bullish, it's time to sit tight because the price may take a nosedive at the moment before it regains upward momentum in the future. On the other hand, this may be an ideal opportunity for swing traders to take profits because the trend is becoming easier to predict.
On the same note, we need to understand that the Gaussian channel indicator isn’t a Holy Grail; it can also give faulty signals. If you look closely at the previous chart, you can observe that the indicator gave a false signal in March 2020 when the price closed below the channel.
To avoid losses, traders use stop-loss and various other methods, which are discussed later in this article.
The indicator can be used in multiple ways. For instance, if you're bullish on Bitcoin, then wait for the price to enter the Gaussian channel. It can indicate a potential trend reversal. To confirm such a move, traders often wait for a candlestick to end above the lower band of the Gaussian channel. Once the price passes through the upper band, it's a sign of a bullish trend. A similar strategy can be used to forecast a bearish trend.
Here’s an overview of a bullish trend:
Traders who seek long-term trades can also wait for the Gaussian channel indicator to turn from green to red, or vice versa. In this case, they're likely to get a more refined signal without false alerts. However, the downside to waiting for the indicator to change color is a delay in entering the market.
While the Gaussian channel indicator is a very powerful tool to detect a trend change, it's recommended to select an entry point based on the level of risk you're willing to take. Some traders also use the middle band to initiate a trade, while others prefer an additional technical indicator to confirm a trend.
If used prudently, the Gaussian channel can detect a potential new trend. However, this can only help if you're also aware of the risks. Understanding such shortcomings will help formulate a viable strategy that can withstand price movements in the wrong direction.
If we're to believe that history repeats itself, then the price-based dynamics of the Gaussian channel indicator can theoretically provide a strong indication of an upcoming trend.
The indicator is easy to follow. For the most part, it's simply buying and selling whenever the indicator turns green and red, respectively.
The system is based on a proven mathematical concept which is still used by statisticians and scientists in formulating scientific theories.
The Gaussian channel is a long-term lagging momentum indicator. In the short term, the price can overly extend beyond the channel, leading to a delayed entry.
Due to the nature of lagging indicators, the delayed entry-exit response requires further analysis or the use of another indicator that can confirm the trend.
Despite its significance, the Gaussian channel indicator is not yet available on most popular trading software. You may need to download it from a third-party source to use it on your preferred platform.
There isn't any universal standard to determine the reliability of any indicator. Despite this, certain factors can tell you if you should rely on technical parameters.
First, look for an indicator that offers more correct signals than incorrect ones. In theory, you’ll be profitable if you can accurately predict the trend more often than not. Despite this theory, very few traders — if any — would consider trading with such an indicator because traders usually look to gain substantial profits.
Therefore, another important metric that traders look for is the potential profit-to-loss ratio. If your indicator is only 50% correct in determining the price, but it offers a good profit-to-loss ratio per trade, it's reliable.
Ideally, a reliable indicator gives correct signals more often than not, and the profit-loss ratio is higher than 2:1.
Based on these two deciding factors, the Gaussian channel seems a very reliable indicator. This is evident from the opportunities reflected in the daily BTC/USD chart. By referring to BTC/USD's chart starting from Oct. 2020, when Bitcoin’s price took off, we can see that the indicator has accurately predicted the trend, both in trending and ranging conditions. This is in spite of the many ups and downs. If you’re a medium-term investor relying on this chart, there were at least four clear trends in either direction.
Additionally, many users tend to rely on the lower and the upper bands of the Gaussian channel indicator as support and resistance for BTC.
Technical analysis is mainly used to determine support and resistance levels. In other words, it’s only good if you're able to pinpoint exact entry and exit points on the trading chart.
Fortunately, the reliability of the Gaussian channel indicator allows traders to devise strategies that fit their trading styles. To get you started, here’s an overview of different strategies you can use:
1. Support and Resistance Levels: The Gaussian channel has a built-in mechanism for entry and exit points. For instance, you can use a candlestick to enter and exit a trade using the upper and lower bands of the channel.
Look for a bullish signal whenever a candle closes inside the channel from below. You can place the stop-loss at the lowest point of the existing trend. Take profit when the trend changes — i.e., the candle closes inside the channel from above.
2. Time Frame: They say that taking a position opposite an existing trend is similar to standing in front of a train. In simpler words, you’ll quickly burn out by going against the existing trend. Instead, it’s more profitable if you follow a trend.
One way to do this is to figure out a daily or weekly trend on the chart. If the long-term trend is bullish, only make a bullish trade. If the long-term trend is bearish, make a bearish trade.
When you follow the trend, you're likely to find a very reasonable profit-to-loss ratio. In the above example, the false entry would have stopped you within a few points, considering that the stop-loss is just above the top of the last candlestick. However, the subsequent entry would reap substantial benefits even with another tight stop-loss.
3. Additional Indicator: Sometimes, the trend is not as clear as you’d like to see. In this case, it's better to use another indicator to confirm the price action. These days, most popular software offers various "moving average crossover" indicators. You can use moving average (MA) crossover to get in and out of a trade quickly during a ranging market.
The Gaussian channel indicator is a powerful tool which can accurately forecast a future trend. You can either use it as a stand-alone indicator, or in conjunction with another indicator to confirm the signal. Irrespective of your trading style, there’s little doubt that the Gaussian channel indicator can provide accurate entry and exit signals in a variety of time ranges and market conditions.