Basic Principles of Technical Analysis for Traders
Today, of the entire set of tools for evaluating the cryptocurrency market at the disposal of traders, technical analysis is one of the most proven methods. Its use helps to more accurately feel the mood prevailing in the market, identify key trends and make more balanced forecasts.
Technical analysts use pragmatic approach, therefore, they analyze the history of price behavior (according to its movement schedules) and use various analytical tools to better understand the situation on the market with respect to one or another asset.
And if, in fundamental analysis, it takes into account how much “should” the asset cost, then at the technical level, on the contrary, only the actual price movement is considered. Analyzing the historical dynamics of the price movement, technical analysts seek to identify such well-known patterns, such as the levels of “support” and “resistance.”
The basis of technical analysis
For a better understanding of technical analysis, it is necessary to know the basic concepts of the Dow theory, which formed the basis of this method for understanding the behavior of the price.
Basic statements of the Dow theory:
1. The market takes into account everything. The current price of an asset is influenced by events of the past, which insist and even predictions about the future. As for bitcoin, factors such as past, current and future demand, and any change in regulation for digital currencies, affect its price. This price displays all the existing information at the moment, including current awareness and expectations of all market participants. Therefore, technical analysts are trying to understand that the current price of an asset speaks about market sentiment in order to give a reasonable forecast of future price dynamics.
2. Price dynamics are not chaotic. Price changes follow trends that can be short-term and long-term. As soon as an asset forms a certain trend, it is more likely that it will follow this trend, rather than go against it. Thanks to technical analysis, traders are trying to recognize trends and extract profit from it.
3. Technical analysis focuses on the historical dynamics of the price of an asset, rather than on certain parameters affecting its movement. Price changes may be caused by completely different factors, but technical analysts look directly at the effect of supply and demand.
4. Market history repeats every time. The market psychology is quite predictable and traders often react equally to the same circumstances. For example, digital currency markets often respond with bullish sentiment to news of wider adoption of cryptocurrencies.
Technical Analysis Methods
There are a lot of methods used by technical analysis. But they are divided into several specific classes:
1. Levels and lines of resistance and support
2. Technical Indicators
3. Patterns on big parts of the chart
4. Candlestick analysis
5. Trade volumes
Usually, experienced traders combine several different techniques in their methods and wait for their mutual reaction — this reaction can be considered as most reliable for making deals in the market.
- Levels and lines of resistance and support
The price is always changing, this is what forming a chart, there are peaks and dips that mark the highs and lows. If you draw a line along a series of highs or lows, it will be called — the line of resistance or support.
These are the values of the quotes on which the cryptocurrency rate feels a significant obstacle, after which a reversal is possible. Horizontal support and resistance lines are called levels.
Strong levels of support occur in places where large numbers of large buy orders accumulate. The same with the resistance level, which is determined by the presence of a significant list of sell orders. One of the main definitions faced by traders is the trend and trend price movement. A trend is a channel composed of parallel resistance and support lines.
The direction of the trend movement is determined by the slope of the lines. If they are directed upwards, then the trend is called upward. This means that the cryptocurrency trade is conducted with a predominance of purchases. For a downtrend it is opposite. A side trend (or flat) is a movement in which the resistance and support lines are horizontal and there is an approximate equality of sales and purchases.
Main figures of technical analysis
The figure is a picture which describes the change in the price of a crypto instrument that traders again and again notice on the chart.
Head and shoulders
The head and shoulders reversal pattern is quite common after a strong and long-lasting trend. The figure consists of three consecutive peaks, the middle of which (head) is the highest, and the other two peaks on the sides (shoulders) are lower and almost equal.
1. Determination of the trend
First of all, it is necessary to state the development of an upward, bullish trend. A strong upward trend must necessarily precede this graphical model.
2. Left “shoulder”
Then we wait for the formation of the left “shoulder”, which on the chart looks like a new maximum with the subsequent correction. Moreover, the lowest correction point, as a rule, is not below the current trend line.
Now, after the completion of the correction, it is the turn of the “head”. It looks like a powerful price momentum in the direction of the current trend. It sets a new maximum, but the price immediately rolls back to the same level from which the momentum started and breaks through the current trend line. This casts doubt on the strength of the bull trend.
4. Right “shoulder”
But the strength of the bulls is still sufficient to try to rectify the situation, so they enter the market and push the price up. However, the lack of potential buyers leads to the fact that the price cannot put a new maximum and rolls back, forming the right shoulder of the model. Although the theory assumes that the right and left “shoulders” will be symmetrical, in practice this is not always the case.
5. Breakthrough of the “neck” line
After the price rolls back, failing to put a new maximum, it approaches the so-called “neck” line, which is held at the minima of the left “shoulder” and “head”. The “neck” can have an upward slope, a horizontal position or a downward slope — depending on the correlation of the forces of bulls and bears. A classic sell signal appears when the price breaks down the neck line.
6. Target profit
It is recommended to leave this trading position after the price overcomes a distance equal to the distance from the maximum of the “head” to the level of the “neck”. But this is only an approximate goal, which needs to be refined using other tools, such as support and resistance lines.
Double bottom or double top
Double bottom is one of the most common patterns encountered after a downtrend a double top after an uptrend. The “Double bottom” figure is very similar in nature to the “Double Top” figure. They are identical, with the only difference being that they are a reflection of each other.
Usually, the classic double bottom foreshadows at least a small change in the direction of the trend. The main price movement, which makes the Double bottom, is considered the intersection of the resistance line from the bottom up.
The “Rectangle” shape is easy to see on the chart. The rectangle is a kind of pause in the trend, during which buyers and sellers are about equal. The distinctive features of the rectangle — smooth lines of support and resistance; support and resistance are the two horizontal sides of an imaginary rectangle.
The rectangle is a simple figure in technical analysis that demonstrates the struggle between sellers and buyers.
Flag and pennant
The flag and pennant reflect a short period of consolidation in the framework of a dynamically developing price movement trend. Formation of such models should be preceded by a sharp change in prices. The consolidation figure itself is limited by lines of support and resistance that are parallel or slightly converge, forming a figure similar to a flag, inclined, as a rule, in the direction opposite to the direction of the trend, or located horizontally. After the breakdown, the price movement should at least repeat the distance traveled before the formation of the figure.
More complex methods of working with graphic patterns, such as Candlestick and Trading volumes, can also be used in cryptocurrency trading. But their description will be too long for this article. We will discuss them in the next article.