Technical analysis began to be used on traditional exchanges long before the emergence of digital assets. Now it is actively used on the cryptocurrency market as well. The basic principles of such trading have not changed much, and the main innovations have affected the programs and tools to optimize the trader’s work.
The theory of technical analysis in the cryptocurrency market
Those who are not familiar with the cryptocurrency market may think that price charts change chaotically. Proponents of fundamental analytics often argue that with the help of technical analysis it is impossible to determine the cause of price changes and predict future movements. However, technical analysis is based on a quite fundamental theory that the dynamics of price changes depends on the psychology of market participants. In similar situations people behave in the same way, and the balance of supply and demand is formed under the influence of human instincts – herdness, greed, euphoria, fears, panic, etc.
In this case, the actions of each individual trader do not matter. The “crowd psychology” – the main driving force of the price of any asset – is at work here. It is the understanding of such processes that allows you to predict the movement of rates.
Goals of technical analysis of the cryptocurrency market
Technical analysis is the process of studying information about how the rate of cryptocurrency or any other asset changes. The main goal is to find prices on the chart at which buyers are ready to buy and sellers are ready to sell. These price points are called support and resistance levels. When the price approaches one of these marks, its “behavior” changes according to one of two scenarios:
- rebound and reversal;
- “breakdown” of the mark and a strong impulse to continue the movement.
At the same time, the “breakdown” can be false, when the price slightly passes the level and then sharply turns in the opposite direction.
Successfully identifying these levels, the trader can open positions in a favorable direction, that is, buy cryptocurrency before its price begins to rise, and sell before the rate begins to decline.
Depending on the strategy, the analysis may take into account additional factors – for example, trading volumes, the amount of open positions, the number of realized orders, etc.
Basic principles of technical analysis of cryptocurrencies
There are three basic principles of technical analysis of cryptocurrencies.
History repeats itself
This rule is based on the same crowd psychology. If market participants react in the same way to the same situations, it means that their reactions are already on the charts and are periodically repeated. Traders try to identify patterns in historical data to anticipate future changes.
All factors affecting the price are already embedded in the chart
According to technical analysis theory, the current price takes into account all events and factors that may affect it, including:
- technology, marketing and project prospects;
- political and economic events;
- natural or man-made events.
Under the influence of these factors, the price has settled at the level it is at now. That is, the current rate of the cryptocurrency corresponds to its real price.
The price moves according to trends
A single fluctuation in the chart can be a fluke. A sequence of fluctuations over a period of time is already a trend, that is, the direction in which the price of cryptocurrency is moving. However, any movement will sooner or later end, and the price will go in another direction. The trend itself does not look like a straight line either: it is a certain range of consecutive minimums and maximums.
Conventionally, trends can be divided into three categories:
- sideways – the price fluctuates around the current level without strong deviations;
- upward – this is a sequence of fluctuations in which each successive maximum exceeds the previous one;
- descending – each minimum is lower than the previous one.
The task of the trader is to identify the current trend and in time to anticipate its stop or change.
Features of cryptocurrency trading by technical analysis
Cryptocurrency trading by technical analysis is conducted according to the following rules:
- All cryptocurrencies are the same. It does not matter to the trader what to trade: if he sees a suitable situation on the chart, he opens a deal.
- Direction does not matter. An experienced trader can earn both on the growth and fall of the price of cryptocurrency.
- There is no bottom and ceiling. No matter how much the cryptocurrency rate rises, it can go even higher. And vice versa: no matter how much the rate falls, it can fall even lower.
- Refusal to speculate. The purpose of technical analysis is not to determine the cause of a price rise or fall (except crowd psychology).
- Refusal to support projects. The trader does not “hope for the best”, does not “believe in the team”, does not “want to support the project”, etc.
- Ignoring fundamental factors. The trader does not study projects, their technologies, development features, business methods, etc.
- Ignoring the news background. If there is an event that greatly affects the price of cryptocurrency, then the trader simply stops trading for a certain period.
If a trader violates any of these rules, then he is not trading according to technical analysis.
A timeframe is a time interval that is used to record price fluctuations: for example, a minute, 15 minutes, an hour, 12 hours, a day, a week, a month. A sequence of such intervals forms a chart.
Depending on the timeframe used by the trader, there are several strategies:
- Scalping – with such trading, positions can be held open for a period of a few minutes to an hour, rarely more.
- Daytrading – intraday trading. As a rule, positions are held open for several hours, rarely longer than a day.
- Swing trading – trades are held open from one day to several weeks.
- Medium-term trading – a trader can hold a position open from several weeks to a year.
- Long-term trading – this method is used by passive investors who hold their positions for a year or more.
On short timeframes, traders analyze not only the chart but also order stacks to determine the current mood of the crowd.
Types of price charts
The exchange terminal allows you to build price charts in different ways. Thus, the same information is displayed in different ways.
Such a chart is built in the form of a curved line that connects the end points of periods (minutes, hours, days, etc.). Such a line does not show the maximum and minimum values within one period. It is considered that it does not provide enough information for technical analysis, so it is rarely used in practice.
This chart shows the closing level of the period, as well as its maximum and minimum price. A bar is a vertical line that contains the necessary information:
- top of the line – the maximum rate of the cryptocurrency for the period;
- bottom of the line – the minimum rate;
- the notch on the left – the opening price;
- the notch on the right is the closing price.
If the line is red, it usually means that the closing level was lower than the opening, and if it is green – vice versa.
This chart works similarly to bars, but instead of lines, two-sided candles are used:
- The upper wick shows the maximum price for the period.
- The lower wick shows the minimum one.
- The lower and upper end of the candle’s body shows the opening and closing levels.
The red color of the candlestick usually indicates that the closing level was lower than the opening, while the green color indicates the opposite.
Technical analysis patterns
To systematize the known patterns of crowd psychology, traders distinguish figures of technical analysis. These are patterns and models that have repeatedly shown themselves in real market conditions. When a familiar figure appears on the chart, a trader opens a position in the right direction.
Rectangle (box, corridor)
This is one of the simplest figures, which is formed by two straight lines (support and resistance levels). The price moves between them for a certain period of time.
There are three variants of using such a figure:
- Trading inside – a series of deals that are opened and closed on the approach to the lines of the rectangle.
- Upward breakout – opening a long position after passing the resistance level.
- Downside breakout – opening a position in short after passing the support level.
As a rule, after breaking through the level there is a strong impulse of price movement. The longer the rectangle was formed, the stronger this movement will be.
Triangle is also a rather simple figure, which is formed by two lines when volatility fades. It is expected that once one side of this figure is broken, the movement should continue. The sharper the top of the triangle, the sharper and longer the momentum will be.
This figure is similar to a triangle, but it has both sides pointing in the same direction (up or down). The wedge is considered a reversal pattern, so its completion is easier to predict:
- an ascending wedge breaks downward;
- a descending one – upwards.
This is its fundamental difference from a triangle, which can be broken both upward and downward with the same probability.
Double top (double bottom)
This is also a reversal pattern, which is quite easy to identify on the chart. A double top is formed at a level that the trend cannot break through twice. After that, the chart reverses and goes in the opposite direction. The situation when the second top is smaller than the first one strengthens the trend.
Head and Shoulders
Another reversal figure consisting of three tops, among which the middle one is higher (or lower) than the other two. The deal should be opened after the second shoulder appears, a more risky option – on the third top (since the figure is not yet formed).
Technical analysis indicators
Technical indicators are additional metrics that are the result of automatic analysis of cryptocurrency charts according to specified algorithms. They can be divided into four main categories:
- trend indicators – display the direction of the trend;
- momentum indicators – measure the speed and power of price movement;
- volatility indicators – determine the amplitude of the rate movement;
- volume indicators – show the strength of the trend taking into account the trading volume.
Depending on the strategy, a trader can use several indicators at once or do without them at all.
Volume is considered to be one of the basic indicators of technical analysis. This indicator displays the volume of transactions in each candle and allows you to determine the reliability of the formed trend.
The volume profile works similarly to the standard volume, only it is displayed on the chart from the side, not from the bottom. This allows you to determine the volumes that were realized at specific price levels.
The Relative Strength Index (RSI) is a momentum indicator that helps to analyze recent price changes and determine whether a cryptocurrency is overbought or oversold.
Stochastic RSI also determines overbought and oversold. It is considered an “amplified” version of the basic RSI, as it works according to more stringent criteria.
Moving Average (MA) is a line that shows the average value of a cryptocurrency over a certain period of time. The interval can be manually adjusted.
Moving Average Convergence/Divergence (MACD) is an indicator that allows you to determine the strength and direction of the trend, as well as find reversal points. It consists of two moving averages, at the crossing of which you should open a position.
Bollinger lines are two moving averages, the distance between which reflects the level of volatility of the cryptocurrency. If the price goes beyond the upper or lower line, it indicates that the cryptocurrency is overbought or oversold.
The Ishimoku cloud takes into account the performance of five moving averages to identify support and resistance levels, and also allows you to predict the strength and direction of the trend.
Fibonacci levels is an indicator that shows several support and resistance levels. It is based on the idea that the chart showing the crowd’s behavior corresponds to the proportions of the golden ratio.
The main mistakes in the technical analysis of cryptocurrencies
The extent to which the theory of technical analysis will be successfully applied depends primarily on the emotional state of the trader himself. Any emotions – both negative and positive – negatively affect the results of trading, leading in most cases to losses. Traders are recommended to stay completely calm.
It is not difficult to learn patterns and indicators. It is much more difficult to constantly follow the planned strategy. If a trader’s psychological state destabilizes, he begins to violate his own trading rules. For example:
- Unrealized profits. A trader may close a profitable position too early and thus reduce his profit from the deal.
- Reduced profit. A trader may fail to close a position at a local high, waiting for a continuation of the movement. After the reversal, he will lose some or all of his profit.
- Premature losses. A trader may close a losing position too early. If the price reverses, he will not get his profit.
- Excessive losses. A trader may not close a losing position for too long, waiting for a reversal. As a result, he will lose a significant amount of money.
- Excessive self-confidence. After a series of successful trades a trader may “believe in himself”, start to analyze the chart less carefully and make mistakes.
- Gambling. After a series of losing trades a trader may start to take more risks in order to “win back”. As a result, it is possible to get even more losses.
- Information noise. A trader may open trades not according to his own strategy, but according to recommendations of famous personalities, bloggers, news publications, etc. As a rule, this also leads to losses.
One cannot do without losing trades in trading. The trader’s task is to make his profit more than losses, and for this purpose it is necessary to adhere to the planned strategy.
Experienced market participants advise to carefully monitor their psychological state and stop trading in case of excessive emotionality. It does not matter whether these emotions are caused by the trading process itself or by external factors. For example, a person may be in a high mood during a vacation or depressed because of problems in the family. In such periods it is better to refuse trading.