If you believe that Technical Analysis was created by magical stock market elves and is completely based on chance, luck and crystal ball logic, this article is not for you.
This article is written for the trader looking to improve both the percentage profitability of his trading and his risk management strategy through the proper understanding of Technical Analysis principles. If you are the type of trader that has an open mind for learning new skills and taking on new challenges, congratulations, you have already won.
The Tools
- Trend Lines
- Support and Resistance Levels
- Moving Averages
- Trading Volume
Trend Lines
Trend lines show the current price direction by joining the low price points together with a single line on a chart. These lines are incredible simple and can be very beneficial for cryptocurrency traders. Trend lines can be used to identify long term and short term trends.
Example 1
In the first example trend lines were used to find incredibly long term market trends. The chart is slightly over one year long and highlights the consistent trend that the Ethereum project has been on during that time.
Example 2
In the second example we can see a much shorter term trend. If you were a buyer each time the price came close to your trend line you could protect the entry with a stop loss under that line and created a very profitable short term trade.
Example 3
Trend lines don’t always have to be going up. They can also be used to determine key resistance levels when an asset is in a downward trend. This example shows Ethereum and the down trend that it was in since the beginning of 2018. Each time the price approached the trend line, it fell sharply. It isn’t until this trend line is broken that the price can recover and begin to move upwards again.
Accuracy Is Everything
There is an ongoing debate amongst technicians between trend lines should be drawn from the open/ close of the candles (the body) or the high/ low (the wick). Whatever method you decide to employ, the most important thing is that you are consistent. Use either method, but do not combine the two.
Support And Resistance Levels
There can be some confusion between trend lines and support and resistance levels. Since trend lines can technically be considered either areas of support or resistance for the purposes of this article “Support and Resistance levels” will only refer to horizontal price “pivot” areas.
A support level is confirmed by the fact that at a certain level there is a considerable amount of traders who are willing to buy the coin, aka demand. Those traders believe that at this level the coin is either at a discount, or a fair price and are willing to make the purchase based on the assumption the price will go back up. A level of resistance is exactly the opposite — an area where many sellers believe that the price cannot go above. Therefore every time the coin approaches that “ceiling”, it encounters the supply and the price retreats
Example 1
In this example you can see that when a price returns to one of the previous support levels inside the green boxes it bounces back up. This happens three times. On the fourth re-test the price manages to break through, this indicates that the price will be heading down to the next level of support. In this case around $600.
Example 2
In this example you can see that when a price returns to one of the previous resistance levels inside the red boxes it bounces back down. That is a bearish indicator, as the price is unable to break through the previous resistance level, and therefore must fall back to it’s nearest support.
Breakouts
A breakout occurs when the price reaches a previous support or resistance level and then “breaks out” either by exceeding that resistance or falling through that support.
Breakouts are commonly followed with a surge in volume as bulls become bears and vice versa as their “safe area” is defeated and they are forced to consider the possibility that they are about to be on the wrong side of the trade. A false breakout occurs when the breakout is sudden however the trend does not change and the price quickly retreats back to the mean and re-enters the original channel between support and resistance.
Moving averages
One of the most commonly used tools for identifying current price trends are moving averages. A moving average is based on the average price of the coin over a certain period of time which the user can stipulate. For example if you are using a 20 period moving average on your chart, and your chart is set to the 1d timeframe your moving average will show you the average price of the coin over the last 20 days.
There are two different forms of moving average Exponential Moving Average (EMA) and Simple Moving Average (SMA or MA). The EMA gives more weight in it’s calculation to the price values of the most recent few days than the days earlier. For the purposes of this demonstration we will be using the Simple Moving Average.
50 day and 200 period moving averages
The chart below features one 50 and one 200 period moving average. The chart is set to 240minutes (4 hours). You can see how useful the averages can be for tracking market trends and by using a simple system of purchasing when the short term MA (50) goes above the long term MA (200) would have resulted in you capturing a large chunk of the move.
Trading Volume
While all of the indicators outlined in this guide so far are built around price, there is one that stands out away from the field. That indicator is volume. Volume is a representation of the amount of trades that have occurred within a given time period.
Trading volume is an incredibly important indicator. Large moves in price are almost always accompanied by larger than usual trading volumes while consolidation periods typically have lower volume.
Example 1
Volume spikes can also be a great trend reversal indicator. As you can see in the chart below both previous spikes in sell volume on the Ethereum chart were the end of the trend and signalled the bottom of the move.
This is a common pattern that can be identified on a wide range of cryptocurrency assets. The heightened sell volume usually signifies the bottom because it is when the final round of ‘hodlers’ end up dumping their bags in one last emotional wave. Then, as there is no longer anyone left to sell, the price reverses and begins to move up. Buyers realise the price is undervalued and sellers begin to see the error of their mistakes and become buyers.
Conclusion
To take what you have learned here and start honing your craft as a technical analyst means you will need certain tools. All of the above charts are drawn with Tradingview using their built in selection of drawing tools and comprehensive list of indicators.
This guide has aimed to outline some of the basic concepts of technical analysis that are commonly seen and used to analyse the market. Now it is your turn, safe trading!
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Written by the team at CoinLoop
The #1 Cryptocurrency Dashboard and information platform.
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