How to Apply Technical Analysis to Cryptocurrencies
There are two primary methods used to make investment decisions:
- Fundamental analysis involves analyzing a company’s financial statements to determine the fair value of the business
- Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends to determine future price movements.
The price of an asset reflects the sum total knowledge of all market participants; their analysis, views and actions.
What is Technical Analysis?
Technical analysis is the study of statistical trends, collected from historical price and volume data, to identify opportunities for trade. Technical analysts observe patterns of price movements, trading signal and other analytical tools to evaluate the strength and weakness of an asset.
Technical Analysis can be applied to any security with historical trading data such as cryptocurrencies, forex, commodities and stocks.
Why does Technical Analysis work?
A chart of prices and volume represents all the past decisions taken by market participants (buying and selling). This information will, in turn, affect future participant decisions in two ways:
- Psychological: What you did in the past affects how you approach future situations. For example, many traders tend to focus on the price at which they bought an asset, and if it declines, they want to sell when it reaches break-even again.
- Reflexive: Some traders identify trends and chart patterns which are common, and act accordingly (buying or selling). If a sufficient number of participants follow the same strategy, it is expected that these chart patterns will follow the expected outcome and that the trend will likely to be sustained by more and more participants joining the trend.
What are trends?
There are three possible trends:
- Uptrend: In an uptrend, the asset is going up making, higher highs and higher lows.
- Downtrend: In a downtrend, the asset is going down making, lower highs and lower lows.
- Sideways trend: In a sideways trend the asset trades in a horizontal channel
Sometimes traders also use the terms “Bearish” and “Bullish” to refer to a trend. Bullish comes from the bull, who strikes upwards with its horns, thus pushing prices higher and bearish comes from the bear, who strikes downward with its paws, thus driving prices down.
What are resistance & support?
Movements are not linear, the price will face resistance as it goes up or support as it goes down.
- Resistance: A level where an uptrend can be expected to pause or rebound that indicates a concentration of sellers.
- Support: A level where a downtrend can be expected to pause or rebound due to a concentration of buyers.
When the resistance level is broken it usually becomes a support level and vice versa.
In technical analysis, support is often used as an entry point and resistance as an exit point. In the case of strong trends, the price can go through support/resistance without stopping.
Advanced Technical AnalysisTools
If you’d like to go one step further in your analysis, here’s what analysts often look at:
OHLC Charts (Open-High-Low-Close):
These charts display bars that are known as ‘candlesticks’. A candlestick's shape varies based on the relationship between the day's high, low, opening and closing prices.
- Bullish candle (can be green or white): The close is above the opening
- Bearish candle (can be red or black): The close is below the opening
Candlestick charting is based on a technique developed in Japan in the 1700s for tracking the price of rice but a suitable technique for trading any liquid financial asset. Candlestick can be studied individually (simple patterns) but more often used in groups (Complex patterns). The purpose of Candlestick charting is to determine the market trend.
Simple moving average
An average of the closing price of the stock over a specified number of period.
Bollinger Bands display a graphical band (the envelope) with a simple moving average in the middle. The width of the envelope expresses the volatility.
Volatility refers to the rate at which the price of an asset can increase or decrease. A higher volatility means that the asset can potentially fluctuate rapidly within a larger range of value.
Moving Average Convergence Divergence (MACD)
Moving Average Convergence Divergence (or MACD) is a trend following indicator that looks at the combination of two moving averages:
- A short-term moving average
- A long-term moving average
These two moving averages are combined to identify what is the current trend and if there is a change in the momentum.
The MACD lines displayed below can be interpreted as follows:
- If the blue line (MACD line) is above the orange line (Signal line), the momentum is bullish.
- On the contrary, if the blue line is below the orange line, the momentum is bearish.
- When the lines diverge, it denotes a strengthening of the current trend while a convergence shows a trend reversal.
- When the lines cross, it is likely that the change in momentum is confirmed.
How news can affect asset prices?
One of the most effective means of influencing the public is media. Breaking news and headlines may instill panic and fear in a mass manner, as well as euphoria. The impact of news on the cryptocurrency market is perfectly illustrated by the high-profile events in the world. In September 2017, the Chinese authorities have banned ICO which led to the collapse of the bitcoin price — from $ 5000 to $ 3000. However, there is always another side of the coin, Bitcoin spiked when eBay and Dell said they considered accepting Bitcoin.
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