Since the cryptocurrency market is highly volatile, you need to have a strategy to guide your trading. Many crypto traders turn to technical analysis to help them create their strategies. This type of analysis can give you insight into the past movements of cryptocurrency, helping you predict where it will head in the future.
Defining Technical Analysis
To truly understand how to use technical analysis in your cryptocurrency trading, you must be aware of what it means. Technical analysis involves using real-world data to try to predict the future of the market. It involves looking at past statistics of the cryptocurrencies in question, including factors like volume and movement.
Another common method, the fundamental analysis would be evaluating the cryptocurrency’s inherent value. By contrast, technical analysis looks at patterns and analytic charting tools to see the strengths and weaknesses of the crypto, keeping those in mind for its future patterns. Traders of more traditional assets, including stocks, commodities, currencies, futures, and forex also use technical analysis. The process of using technical analysis on any of those assets will be incredibly similar to that of using it with cryptocurrencies.
The Basic Ideas Technical Analysis Is Based On
There are a few ideas that are part of Dow Theory and serve as a background offering the basis for technical analysis. To start with, the theory indicates that pricing in the market includes consideration of everything. For cryptocurrencies, that “everything” includes current, future, and past demand, regulations, expectations of traders, trader knowledge of the cryptocurrency, and more. With technical analysis, traders analyze the price to see what it suggests about the market sentiment.
Technical analysis works on the principle that history repeats itself when it comes to crypto pricing or trends. Based on this fact, technical analysts aim to make predictions regarding market psychology and the cryptocurrency.
Technical analysis also relies on the idea that movements in terms of pricing are not ever random. Instead, these price movements follow short- or long-term trends. In most cases, when a cryptocurrency follows one trend, it will eventually follow the opposite trend as well. Technical analysis traders will try to isolate these trends to make profits.
Overall, technical analysis cares more about what is happening than why it happens. The focus is on supply and demand instead of worrying about dozens of variables that influence price movements.
Reading Candlestick Charts
The most popular type of graph crypto traders use for technical analysis is a candlestick chart or graph. It can seem intimidating at first but is fairly easy to understand once you get the hang of the chart.
The name candlestick comes from the fact that each plot point on the graph appears similar to a candlestick. They are rectangles that are either red (or pink) or green and have a line coming out of the top or bottom, like the wick of a candle. The size of the candlestick and its line, as well as the color, tells you crucial information.
The top and bottom of the candlestick’s main rectangle are at the opening and closing prices of the cryptocurrency for that day. Green candlesticks indicate that the crypto rose in value so the opening price is at the bottom and the closing price is at the top. Green is positive as the coin increased in value. Red (or pink) candlesticks indicate that the crypto fell in price, so the opening price is at the top and the closing price is at the bottom.
The wicks can come out of the candle on either end of the candle. These show the lowest and highest prices that the cryptocurrency reached within the same period. In other words, the wicks give you an idea of how volatile the market currently is.
Gaining Basic Information From Candlestick Charts
At the most basic level, you can use candlestick charts to see how the cryptocurrency in question did to make predictions for the future. If, for example, the wicks are long, this indicates a highly volatile market. That, in turn, means that the cryptocurrencies have a higher chance of having given you significant losses or gains in the relevant period. Furthermore, high volatility means the market may correct this tomorrow.
When the candlestick’s wick is short, however, this indicates a potential change to the market. When the top wick is short, it is likely that the highest price of the crypto that day was significant for the coin’s history. In the case of a longer wick at the top, it indicates the coin was significantly more expensive at some point in the day before traders sold it for profit. That type of pattern can indicate an upcoming bearish market that will go down.
Noting a short wick on the bottom indicates people continue to sell the coin. As this would increase the supply, the cryptocurrency’s price will likely drop more. A longer wick, by contrast, indicates the price previously dipped and people think it will not get lower. In other words, traders want to buy the crypto at its lowest value and feel it is now. That can translate into future upward movements.
Understanding and Using Trend Lines
One of the first elements of technical analysis traders should learn is trend lines. Trend lines indicate the direction that the cryptocurrency moves, but they require some analysis to determine. That is particularly true given the volatile nature of cryptocurrency. Thanks to that volatility, technical analysis needs to find the overarching trend going up or down amidst all the smaller highs and lows. To make it even more complicated, trends can move sideways. Sideways trends indicate that a cryptocurrency has not moved significantly up or down.
Most software for trading or tracking cryptocurrency will include integrated trend lines. These may be automatic, but you can also place your own trend lines with a greater degree of accuracy. The more accurate the trend line is, the more accurate your predictions will be.
The specific method of drawing an accurate trend line varies based on the analysis program you use. In most cases, you start by placing the trend line right on the candlestick’s lowest price. From there, you roughly extend the line so that it touches the next candlestick’s lowest point. Take care that you get the exact lows for both, so make any necessary adjustments. From there, you should be able to extend the line automatically.
Understanding Support and Resistance Levels
Another concept to understand in technical analysis is support and resistance. Both of these are horizontal lines you can draw onto your trading chart to gain insight into the cryptocurrency.
The support level is the point at which traders want to purchase the crypto in high quantities. In other words, there is a large demand since traders feel that the crypto is low. When the crypto approached the support level, there will be a big demand that typically halts the decline. In some cases, it can even shift the momentum upward.
Resistance levels are the opposite. In this case, there is a heavy supply without much demand. Buyers feel the crypto is overpriced at this point and resist buying it. If the crypto’s value approaches this resistance level, it will find an overabundance of supply, which pushes the price back down.
Sometimes, technical analysts of cryptocurrency will notice variations on this. In these cases, buyers may gather by the support lines and sell the crypto by the resistance line. That tends to happen more often in the case of lateral movement.
If your technical analysis includes a breakout of support or resistance levels, this likely indicates strengthening to the current trend. The trend gets reinforced even more if the resistance level turns into the support level. Keep in mind that false breakouts can also occur, in which case the trend will not change. Because of that, technical analysis requires looking at multiple figures to define trends.
Understanding Trading Volumes
Looking at the trading volume of a cryptocurrency can help you determine whether a trend is significant. High trading volume tends to indicate a significant trend you should take note of. By contrast, low trading volume indicates a weak trend that may pass quickly.
To apply this knowledge, check the trading volume if a cryptocurrency drops in price. Look for a low volume in the declines and higher volumes in the increases. This would indicate the crypto is likely in a healthy trend with long-term growth. By contrast, if the volume during those declines goes up, then the upward trend will probably end soon. Volume can also give you similar information but as the opposite in the case of a downtrend.
Understanding Market Caps
The cryptocurrency market cap gives you an idea of a coin’s stability when using technical analysis. To calculate market cap, just multiple the total circulating supply by the price of each coin. Cryptocurrencies with larger market caps tend to be more stable.
Understanding Relative Strength Index
Most cryptocurrency charting programs will also include Relative Strength Index or RSI indicators. The RSI’s formula is 100 – (100/(1-RS), with RS equaling the ratio separating the average number of days that a coin was up to the average of how many days it was down. Your chosen chart will automatically calculate this for you, typically displaying it under your candlestick chart.
The RSI can be anywhere from 0 to 100. RSIs close to 30 or lower indicate that the crypto is currently undervalued and you should expect a rise in price. RSIs that approach or go above 70 indicate the crypto is overbought, so its price may drop.
Understanding Moving Averages
Moving averages is a part of technical analysis that helps you recognize trends. The moving average depends on a crypto’s average price over the chosen period. The typical calculation of a day’s moving average is based on the past 20 days’ trading prices of the coin. You can connect all of the moving averages to create a line that you extend out to guide your predictions.
Exponential moving averages (EMAs) are a type of moving average. This type of calculation is more complicated as you give increased weight to the most recent price values. For example, you may give the most recent five days double the calculation coefficient of the 10 days before it in an EMA over 15 days.
To gain deeper insights using moving averages, you can use several of them, each of a different length of time. If the shorter-term moving average crosses over a longer-term one, this might indicate an upcoming positive trend.
Choosing Time Frames
As you work to conduct your technical analysis, you will have the ability to set your own time frames on the price chart. Some common options include 15 minutes, hourly, four hours, and daily charts, although there are numerous others. You should choose your time frame based on your style of trading.
Intra-day or short-term traders tend to open and close positions all within one day. If you fall into this category, then you should stick to short time frames on the charts. Common choices for intra-day traders include five minutes, 15 minutes, and an hour. You would not typically want to use a longer time frame than this.
Long-term traders hold positions over a much longer period of time, which may be weeks, months, or even years. Long-term cryptocurrency traders should look at larger time periods, such as four-hour, daily, or weekly charts. If you fit into this category, you may also consider using hourly charts, but this would be less common.
Combine Technical Analysis With Other Methods
Ideally, you should never rely solely on technical analysis when trading cryptocurrencies. It is best not to use any single analysis method alone as this will give you limited information. If you were to rely just on technical analysis, you would not get any insight into sentient or news, which are part of fundamental analysis. This is particularly problematic with cryptocurrency trading since factors like mining hash and regulations can have a significant impact on the coin’s price, but technical analysis does not account for them.
Technical analysis can give cryptocurrency traders insight into the past of a crypto, facilitating future predictions. Most charting software has numerous technical analysis tools already built into it and you can supplement these with your own analysis. For the best results, always try to combine technical analysis with other methods.