It goes without saying that trading and investing in cryptocurrency necessitate a thorough understanding of the cryptocurrency in question, as well as the general crypto market.
Profiting from the crypto market comes at the cost of a well-crafted strategy. This strategy often takes the following factors into account:
- The reasonable entry price to buy a coin,
- Potential returns or expected price growth, and
- Amount of time required to reach the desired price.
Thus, technical and fundamental analysis form the foundation of investment research.
Fundamental analysts consider macroeconomic and microeconomic trends, industry conditions, and the competitive landscape when determining the value of an asset. Conversely, technical analysts seek to understand market sentiment by identifying patterns and trends and forecast price movements by analyzing historical data such as price and volume.
As a budding crypto enthusiast or an investor eager to expand your knowledge, mastering the art of cryptocurrency technical analysis is a vital skill that can significantly enhance your trading prowess. In this beginner-friendly guide, we will demystify the complex world of technical analysis, providing you with essential tools, techniques, and strategies to help you identify trends, predict price movements, and make well-informed decisions in the dynamic realm of digital assets.
What Is Technical Analysis (TA)?
Technical analysis of cryptocurrency entails using mathematical indicators based on previous price action data to forecast future trends. The basic idea is that markets behave in predictable ways and that once established, trends in one direction often continue in that direction for some time.
Investors generally want to buy when markets are near low to sell higher at a later date and thus profit. One of the methods for identifying price levels that may be considered low is performing technical analysis, especially before entering a position.
There is no one-size-fits-all approach to crypto technical analysis. Instead, each trader will have a different preference for indicators and will most likely interpret them differently. You should also note that technical analysis is only partially predictive.
Compared to fundamental analysis, which considers various factors surrounding an asset's price, technical analysis focuses solely on historical price action. As a result, it is used to examine an asset's price fluctuations and volume data, and many traders use it to identify trends and favorable trading opportunities.
How Does Technical Analysis Work?
Technical analysis involves studying past price movements to forecast future price movements. The fundamental idea behind price action is that the price of a trading instrument does not move arbitrarily. Instead, there is a story behind the price movement, and investors can read the price history like a book and forecast what will happen next.
The cryptocurrency market's price fluctuates due to changes in supply and demand. When supply exceeds demand, the price falls; when demand exceeds supply, the price rises. However, the main question is when and how the price will move.
The primary responsibility of technical analysts is to calculate the overall market context and determine the precise point from which the price is more likely to move.
TA is the most dependable and effective method of forecasting price movement. However, it necessitates the use of several tools and elements. Volume and liquidity traders, for example, frequently use various charting tools known as indicators in addition to candlestick charts.
Indicators are a crucial part of technical analysis, and we'll consider them below to understand them better.
Basic Technical Analysis Indicators
Traders who use technical analysis typically use various indicators and metrics to determine market trends based on charts and historical price action. The following are a few of them.
Simple Moving Average (SMA)
The Simple Moving Average is among the most widely used and well-known technical analysis indicators. SMA is calculated by adding a series of prices and dividing the total by the number of data points.
For example, if the three most recent prices are 1, 2, and 3, then the average is the sum of the prices (1+2+3) divided by the number of reporting periods. The total price is six, and the number of reporting periods is three, so six divided by three equals two.
The SMA is called a "moving average" because it is plotted on the chart alongside each bar, forming a line that "moves" with the chart as the average price changes.
When a new price becomes available, the average "moves," so it is always based on a similar number of reporting periods. Applying a Simple Moving Average helps reduce the noise of fluctuating prices to determine the overall trend direction.
Exponential Moving Average (EMA)
The Exponential Moving Average is an altered version of the Simple Moving Average (SMA) that prioritizes recent closing prices over older ones. In other words, the Exponential Moving Average (EMA) is a moving average (MA) that emphasizes the most recent prices.
The Exponential Moving Average (EMA) is also called the Exponential Weighted Moving Average (EWMA). EMA works the same way as the SMA, measuring trend direction over time.
Exponential Moving Average: How to Use Them (EMA)
A trader can use the EMA to determine the current trend and trade in that direction.
- Consider buying when the price falls near the EMA or crosses over the EMA line.
- Consider selling when the price of an asset slips below the EMA line.
You can also use Moving averages to identify areas of support and resistance.
- A rising EMA tends to provide price action support.
- A falling EMA tends to act as a barrier to price movement.
This reinforces the strategy of buying when the price is close to the rising EMA and selling when it is close to the falling EMA.
Like all moving average indicators, Exponential Moving Averages work best in trending markets.
- The EMA line will show an uptrend when the price of a crypto asset is trading above the EMA line.
- The EMA will show a downtrend when a digital asset's price is below the EMA line.
- We should pay attention to the EMA line's slope (direction) and its momentum (rate of change) from one candle to the next.
- Moving averages, such as the EMA, are NOT intended to pinpoint a trend's exact top and bottom.
Moving averages allow us to trade in the general direction of a trend. However, it's a lagging indicator and gives us an entry and exit signal a bit late.
Lastly, the EMA is faster than the SMA. Thus, when EMA crosses SMA from the downside, it's considered a buying signal and vice versa.
Relative Strength Index (RSI)
Another widely used indicator is the Relative Strength Index (RSI), which belongs to the oscillator class of indicators.
In contrast to Simple Moving Averages, which track price changes over time, oscillators apply mathematical formulas to pricing data to produce readings within predefined ranges. This range is 0 to 100 in the case of the RSI.
Relative strength index (RSI) is a technical momentum tool that displays whether an asset or cryptocurrency is overbought or oversold. RSI is an oscillator that determines high and low bands between two opposite values while estimating the magnitude and speed of price variations.
Because of the volatility of the stock and cryptocurrency markets, technical indicators serve as a guide for determining entry and exit points. As a result, RSI is a reliable indicator for cryptocurrency traders.
Some traders take it further by using Stochastic RSI to learn more about the market's sensitivity. Aside from the more basic and straightforward technical indicators, some indicators generate data by relying on other indicators.
Stochastic RSI, for example, is calculated by applying a mathematical formula to the regular RSI. It is a technical indicator that ranges from 0 to 100 and is created by combining a stochastic oscillator formula and the RSI.
Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence (MACD) indicator is another well-known example. The MACD is calculated by subtracting two EMAs from the mainline (the MACD line). The first line is then used to create another EMA, yielding a second line (the signal line).
There is also the MACD histogram, which is calculated using the differences between those two lines:
MACD = 12-Period EMA − 26-Period EMA
How to trade MACD?
- Bullish Crossover: MACD is considered bullish when it crosses above (midpoint) zero.
- Bearish Crossover: MACD is considered bearish when it crosses below (midpoint) zero.
Bollinger Bands (BB)
The Bollinger Bands (BB) technical indicator is another popular oscillator type among traders. The BB indicator comprises two lateral bands that circle a Moving Average line. It is used to identify potential overbought and oversold market conditions and measure market volatility.
Bollinger Bands are a technical indicator that consists of three lines that form a channel containing the price action. The line in the middle is a simple moving average (SMA), and the upper and lower lines are derived from it and move in response to price volatility.
Traders use Bollinger bands to determine the current trend, measure volatility, and forecast potential reversals.
Price Action Trading
Price action uses price fluctuation and volume charts to predict what will happen in the future. There are no tools explicitly designed for price action traders. On the one hand, traders can profit by analyzing the price chart, while other traders use price levels, patterns, and indicators to observe the price action.
The price of a financial asset, such as a stock, currency pair, or cryptocurrency, is crucial to trading because the price change determines profit or loss. Traders focusing solely on price charts must devise a price action strategy that analyzes trending waves to choose when to enter or exit a position.
Understanding price action mechanics and developing a highly effective trading strategy can be profitable.
Price action trading entails analyzing trending and pullback waves, also known as impulse and corrective waves. A trend advances when the trending waves are larger than the corrective waves.
To determine the trend's direction, traders look for "swing highs" and "swing lows," or the length of the trending and pullback waves. The rules of an uptrend are that the price makes higher swing highs and lower swing lows. On the other hand, during a downtrend, the opposite is true. On a price chart, trendlines' troughs and peaks float between support and resistance lines.
Candlestick charts, invented by a Japanese rice trader in the 1700s, are an effective way of visualizing price movements. A keen understanding of candlestick charts helps traders better understand market movements.
Candlestick charts are a popular segment of crypto technical analysis because they allow traders to interpret price information quickly and from only a few price bars.
Focusing on a daily chart, each candlestick represents a single trading day. It has three main characteristics:
- The body denotes the open-to-close range.
- The wick, or shadow, indicates the high and low for the day.
- The color that indicates the direction of market movement – A green (or white) body suggests a price increase, while a red (or black) body suggests a price decrease.
The candlesticks form patterns traders can use to identify major support and resistance levels over time. For instance, numerous candlestick patterns indicate a market opportunity – some reveal the balance of buying and selling pressures, while others identify continuation patterns or market indecision.
Pivot Point Trading
Professional cryptocurrency traders use pivot points to identify potential support and resistance levels. Simply put, a pivot point and its associated support/resistance price level are areas where the direction of price movement may change.
What makes pivot points so appealing?
They are OBJECTIVE. Unlike some of the other indicators discussed above, no discretion is involved.
Floor traders were the first to use pivot points to forecast support and resistance price level in the equity and commodities markets. They can also aid in determining overall market trends, as prices that break upward past a particular area can be considered bullish, while prices that pass below the same region can be bearish.
The "five-point system" is the most commonly used method for calculating a pivot point. This is an average of the previous trading period's numerical high, low, and close to plot a course for five levels: two sets of supports, two sets of resistance levels, and a "pivot point."
- Pivot Point P = (Previous High + Previous Low + Previous Close)/3
- Support S1 = (Pivot Point x 2) - Previous High
- Support S2 = Pivot Point - (Previous High - Previous Low)
- Resistance R1 = (Pivot Point x 2) - Previous Low
- Resistance R2 = Pivot Point + (Previous High - Previous Low)
Cryptocurrency pivot points are similar to Fibonacci levels in many ways.
Fibonacci retracements are a widespread technical analysis tool traders use to forecast potential financial market prices. Fibonacci retracements and ratios, when used correctly, can assist traders in identifying upcoming support and resistance levels based on past price action.
It's critical to remember that Fibonacci lines are a tool for confirmation. As a result, the indicator works best when combined with other technical analysis tools like Moving Average Convergence Divergence (MACD), trend lines, Moving Averages, and volume. Generally, the more confirming indicators there are, the stronger the trade signal will likely be.
Why do Traders use Fibonacci retracements?
The cryptocurrency market rarely trades in a straight line and frequently experiences temporary dips called pullbacks or retracements. Therefore, crypto traders use Fibonacci retracements to determine how far a market will deviate from its current trend.
The retracements are based on the golden ratio mathematical principle. The golden ratio is represented by the numbers 0, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. Each number is approximately 1.618 times greater than the previous number.
TA draws six lines on an asset's price chart to calculate Fibonacci retracement levels. The initial three lines are drawn at the highest point (100%), the lowest point (0%), and the average (50%). The remaining three lines are drawn at significant percentages in the Fibonacci sequence: 61.8 %, 38.2 %, and 23.6 %. As per the golden ratio, these lines should indicate the points at which support and resistance levels are met.
The primary purpose of crypto technical analysis is to examine cryptocurrency and forecast future movement. The good news is that financial instruments almost always repeat their previous price movements.
Remember that technical analysis is not flawless, and employing TA does not guarantee 100% accurate signals. Professional technical analysts constantly analyze the weakness of each trade signal and prioritize a risk management strategy.
Traders should comprehend the logic and reasoning behind each Bitcoin movement and use a trade management system to track it. Understanding technical analysis takes time and effort, but it will deliver consistent returns once traders do.
Aside from the criticisms and the long-running argument over whether the method is superior, combining TA and FA is a more sensible choice. While fundamental analysis traditionally refers to long-term investing techniques, technical analysis can provide important information about short-term market events to traders and investors, especially when determining favorable entry and exit points.