Updated: Dec 17, 2021
On the 29th of April, 2020, when Bitcoin soared past the $8000 mark for the first time in two months, many traders and financial investors navigated to the news to understand what was going on. Of course, by way of fundamentals, it made all the sense in the world. The coronavirus had hit China's economy with full force. The Yen was falling fast. The Pound and the Euro had taken major hits as well. The greenback, usually a safe haven in times of pandemic outbreaks, unfortunately, held little comfort. Investors needed a much surer store for their value. While gold held some strength, it was clear that major investors were tilting towards cryptocurrencies, a much secure option for their transactions and investments. Hence the increase in the demand for Bitcoin instigated the rise in cryptocurrency prices.
But while fundamentals are great ways to predict the rise and fall of currencies across the globe, there is another way to ascertain these movements before they happen without the need for number crunching or sitting in front of the news 24 hours a day.
Surely, you must have heard about technical analysis at one point or the other. However, if you don't know so much about it, then here's your chance to begin understanding it and applying it in your trading. Chart technical analysis is very useful and by far one of the most reliable tools for money market trades (forex, stocks, cryptocurrency, etc.). This tool's effectiveness is a hotly debated topic amongst traders, but it has lasted long enough to prove that it is an often effective trading tool.
As you now know, there are two primary methods of analyzing market trends; technical analysis, which uses historical facts and past movements to predict future positions, and fundamental analysis, which deals with the cumulative economic and financial effects like news, events, and other factors on market trends. In this article, we will be discussing in-depth the meaning and approaches to technical analysis.
What is Technical Analysis?
Technical analysis is essentially studying past and current market trends to predict the market's future movement. It uses charts to determine a good deal about price and several technical aspects that may affect trading. The analysis of charts is subtly based on the fact that human behavior is predictable with market trends.
Technical analysis helps determine entry and exit points for traders, which points to a high probability of profit. Behind the charts running haphazardly and the market trends are people making rational and irrational decisions. Human behaviour is a primary mover of the cryptocurrency market. We cannot precisely tell how humans will behave all the time, but most of the time, you can be confident that people will react to a specific situation in the same manner.
If a coin price rises for days or weeks, we expect people to take cash in on their profit. This explains why we often see a price dip right after the pump like you will have when a new coin is listed for exchange or with a major IPO in stocks.
When prices dip, we know that investors are waiting to get at the low prices, resulting in a response rally. The price begins to rise again, and the cycle is activated. Technical analysis helps to predict market trends of this simple human behaviour by identifying price peaks or troughs.
Brief History of Technical Analysis
Technical analysis originated in the Dutch market in the early 17th century. Its records appeared in the account of Joseph de la Vega, an Amsterdam-based merchant. The method was said to have been developed in Asia by Homma Munehisa. Homma Muhenisa created the technique that evolved into candlesticks, which remain a charting tool today. Technical analysis was a necessary tool for trading stocks, and it underwent several improvements from experts in the 19th century.
Experts like William Peter Hamilton, Ralph Nelson Elliot, Richard Wyckoff, and Charles Dow contributed immensely to modern technical analysis development. The advent of specially designed computer software has enhanced the tools and techniques in recent centuries. it has made learning and practices much more effortless.
Technical analysis was created to provide data in trading stocks, but it should not be surprising that it works for cryptocurrency. Most of the logic and psychology that controls the stock market applies to the crypto market. The crypto market is just more volatile and livelier than the rest of the trading markets.
Bullish Movement vs. Bearish Movement
Bear market and bull market are terms that pop up in trading crypto, stocks, or forex. These markets only move three ways -
A market is referred to as bearish when there's a substantial market downtrend over a short relative time. It's a downward price direction, but in technical terms, a market is bearish when it sees a 20% dip or more for 60 days. However, you may find cases where the price direction reverses the market trend, but it's far less likely to happen. And some bearish patterns are less obvious that it may require traders and analysts to use several tools.
Contrary to the bear market, a bull market is characterized by an upward trend in the market over a short period. Both market trends have a sort of crowd psychology behind them, like every other concept that affects crypto market trends.
A bear market is driven by slowing economies, fear, and other poor financial situations, while the bull market is driven by optimism and expectation of a price boom. Both are usual concepts with all other trading markets, but crypto being a highly volatile market allows for extended bullish and bearish patterns.
A sideways market movement is known to be consolidating and referred to as range-bound— in essence, the market is not precise on which direction to go, and trading in this ranging period is riskier. You can have several rallies, corrections, or pushbacks within trends, where the trend appears to be reversing only to resume the original movement after a while.
Moving averages are commonly used technical indicators on crypto charts. Unlike candlesticks formation, they are regarded to provide detailed information on price movement within specific timeframes. They provide detailed insight into price movement because it assesses the daily trend for cryptocurrency. There are two types of moving averages:
Simple Moving Average (SMA): It uses a simple line to represent the arithmetic mean of a given set of prices of the last number of days. For example, you add the closing prices for a particular cryptocurrency over the previous 30 days and divide by 30 to get the 30-day moving averages. 50, 100, and 200-day moving averages are the most common moving averages you'll find with technical analysis because they provide a better indication of trend patterns, reversals, and areas of support and resistance.
Exponential Moving Average (EMA): EMAs provide a faster indication than simple moving averages. They focus on a weighted average and assign more importance to recent prices of the market, hence, making it more responsive to new information.
50-day moving averages and 200-day moving averages are the most commonly combined moving averages to predict the market's potential movement and spot trend reversals. It's a major signal for market trends when the two moving averages cross. The crosses are named:
Golden Cross: This occurs when the shorter moving average (50MA) line crosses over the longer moving average (200MA). This cross means that a bullish reversal pattern (bearish breakout) is imminent.
Death Cross: This occurs when the shorter moving average (50MA) line crosses over the longer moving average (200MA). This means that a bearish reversal pattern (bullish breakout) is imminent.
Most analysts use 200 MA to 100MA for the longer moving average because there is a much larger separation between moving averages. The 50 and 100 don't have such separation and may tend to overlap.
We must take note of the fact that the lines don't have to cross before taking a bearish or bullish sentiment. Once the lines get close to each other, it means that a bullish or bearish breakout is approaching.
Support and Resistance
Support and resistance are commonly used factors in technical analysis to predict the demand and supply pattern of cryptocurrencies. Markets go upward and downward over time; where prices pullback are resistant, that is, areas where the market bounces from a downward trend, are called supports.
Simply put, support is that point on the chart where market price will not go below, and resistance is that point on the chart that restricts the further upward movement of the market price. Both points have indications and may signal traders to take a buy or sell. Support points often witness high buying activity; while resistance points usually mean higher supply and lower demand.
The crowd psychology associated with this concept is that buyers increase at the support points and sellers are hesitant to sell, thereby driving up demand and the asset price along with it. The opposite stands for resistant points.
When prices go above or below these areas, it's known as a breakout, which will then find the next point of support or resistance. Points of support and resistance can often be derived from moving averages. The analysis' composite provides leverage to formulate better trading strategies, provide effective risk management, and critical entry and exit points.
Fibonacci retracement level is something you want to know about as a cryptocurrency trader. It’s more like a rule of thumb, the way you know intuitive stuff. It helps traders spot key buying and selling points.
Fibonacci levels were discovered in one of Leonardo Bonacci’s researches, and a particular sequence of numbers which is later known as the Fibonacci numbers were recorded. The series of numbers was known to describe the natural proportion of things in the universe.
This series of numbers (23.6%, 38.2%, 50%, 61.8%, and 100%) gave rise to ratios used to spot retracement levels in crypto charts and consequently predict support and resistance levels. The Fibonacci retracement level is a proponent of the theory that after a significant price moves in a particular direction, the price will retrace back to a certain point before continuing in the original direction.
You'll see with an asset, a typical thing will be an advancement of 100%, followed by 61.8% replacement. 61.8% or 0.618 is a critical Fibonacci level, where traders often buy in mass. The prediction is that the market trend will return to its previous position. Traders are also always careful at this point as Fibonacci levels are not always precise. Hence, they wait until the price is a few percentages above the Fibonacci levels before entering the trade again.
You could argue that this theory only works because people practice it, something like a self-prophecy paradigm. It becomes more accurate the more people use it .
Candlesticks are also essential tools for technical analysis. They depict an asset's price within a given timeframe through four components:
Open and close represent the price of an asset when the trading period begins and closes, respectively. In contrast, high and low represent the highest and lowest prices reached within the trading period.
The wide solid portion of the candlestick is called the body. It depicts opens and closes for the trading sessions. You can set the range on charts, usually a few hours, daily, or weekly depending on what trade you're analyzing. The thin lines extending from the body are the wick, and it depicts the high and low.
A candlestick appears green (bullish) if the current price is above the opening price and appears red (bearish) if the current price falls below the opening price. This typically explains why open forms the bottom of a green candlestick and the top of a red candlestick while close is the bottom of a red candlestick and the top of a green candlestick.
Price directions are often determined from candlesticks and some of the indicators previously mentioned in this article. Neutral candlesticks patterns like doji and spinning tops mean that the market is moving sideways. Bullish candlesticks include hammer, dragonfly doji, bullish and engulfing, and they indicate buying points. Bearish candlesticks like shooting star, hanging man, gravestone doji indicate selling points for assets.
It is necessary to recognize candlesticks patterns for technical analysis as they indicate entry and exit points.
Asides from the indicators mentioned above, there are still a few other indicators that may prove useful in technical analysis by providing critical points for trades.
Other Technical Indicators
RSI: Relative Strength Index is used to determine whether an asset is overbought or undersold. Traders use it to measure the strength of a market, and it's a line graph that usually runs below the price chart. The indicator runs over 14 days and scales from 0-100, from undersold to overbought.
A score of 30 indicates that the particular asset is undersold, and a score of 70 means that it is overbought.
Chart Patterns: Chart patterns generally refer to the movement of charts to predict future price movements. Like candlesticks, these formations are used to identify approaching bullish and bearish momentum, trend reversals, and trend continuations. Some of the regular chart patterns include cups and handles, head and shoulders, pennants, flag, and wedge.
Time Frames: Time frame is an important technical analysis tool, and it depends on what type of trader you are. Charting software will allow you to set time frames for your chart. Day traders use minutes or several hours’ time frames, while scalpers looking to make a quick profit use a minute or less. Long-term traders and hodlers use charts that run into days, weeks, and months.
What's interesting about time frames is that the analysis can point to different directions in varying time frames. This is why it is advised to always trade on multiple time frames, as it gives a better view of the overall trend.
MACD, Stochastic, Parabolic SAR, Bollinger Bands, and Ichimoku Kinko Hyo (IKH) are several other technical indicators contributing to the technical analysis process. Traders use all of these technical indicators to result in a more accurate result.
Technical analysis seems like a promising way to always make a profit; however, this is not entirely true. Expert traders will often argue over which is a better way to predict market movement -fundamental analysis or technical analysis. This is because a lot of traders usually have had a terrible experience with one of the methods. Hence, they argue that one has the edge over the other. It is safe to say that both methods are impressive, and they cross at intricate points that traders must understand.
As technical analysis will work poorly with bad markets, fundamental analysis also does not necessarily provide all the answers. Human behavior is not predictable, and trading, also, comes with some risk.
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