Essential Premises of Cryptocurrency Technical Analysis
Technical analysis is the discipline by which future movements of securities, currency pairs, and cryptocurrencies are discerned from historical patterns. Simply put, technical analysis is the investment process of using history to predict the future. History, in turn, is analyzed through the spectrum of patterns and indicators within charts. Technical analysis is backed by a few select premises, called the key three, which collectively dictate the assumptions behind technical analysis. Everything related to technical analysis, such as indicators, analyzing charts, and even the entire basis of buying and selling assets based on historical events, is based upon these statements.
History Tends to Repeat Itself
While the idea that history tends to repeat itself may sound self-explanatory, it is actually quite a novel concept. No rules require the prices of investments must act a certain way, and no inherent intelligence correlates historical movement to current and future movement. However, the entire basis of technical analysis requires that history does repeat itself, because if history repeats itself, history can be predicted, and if history can be predicted, money can be made. Assuming the above, tendencies to repeat historical price action must be due to outside influences, namely, the investors themselves. Much of this can be traced back to investor psychology and self-predicting patterns, while much of the rest is due to institutional investment patterns.
The Market Discounts Everything
The idea that the market discounts everything, alternatively phrased as “market action discounts everything,” is a part of the Efficient Market Hypothesis (EMH). The EMH states that prices (within our context, the prices of cryptocurrencies) reflect all available information. Various versions of this theory exist, which are thought of as weak, strong, and everything in-between. Since the crypto market is highly volatile and somewhat more trend-based than other security markets, it is less of an efficient market (relative to most) because prices and price variability may not accurately reflect true value. For example, when Elon Musk tweets about a small-cap crypto and the price increases fivefold, the price increase did not represent an efficient market because the true value of the crypto didn’t change, but the price did.
The idea that the market is not completely efficient opens up the possibility of undervalued prices. Technical analysis, in part, aims to identify discounted price (relative to true value) through technical means. Technical analysts care more about what is most likely to happen given historical movements than what may happen based on information already priced into the security, including trading based on earnings, trends, and hype.
Prices Move in Trends
Trends are an exceedingly important concept to technical analysts. The entire point of charting price movements is rendered illegitimate unless one assumes that prices move in trends and that trends are more likely to continue than reverse.
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