A good investor needs to enter the crypto market with an adequate strategy in their bank. After all, countless events have shown the complexity of the crypto market. But how can an investor properly strategize? One option is to employ suitable technical analysis methods. Learn more about crypto technical analysis in this article.
What is crypto technical analysis?
Crypto technical analysis refers to the use of previous market trends and data to predict the future outcome of an asset. Statistical and quantitative measures are usually applied in technical analysis. However, analysts may employ qualitative data to aid adequate crypto technical analysis. Crypto technical analysis thrives on the assumption that assets tend to follow a certain trend. Hence, these trends often repeat themselves over time. Many investors conduct an extensive technical analysis to have an insight into the asset to be invested in and how it may perform.
Crypto technical analysis should not be mistaken for fundamental technical analysis. Fundamental technical analysis is mostly used in the stock market by analyzing a stock’s intrinsic value. However, technical analysis uses charts and other tools to determine the future price of an asset.
An important component of a crypto technical analysis chart is the candlestick. A candlestick reveals an asset’s price activity over a specific period. It typically comes in two colors: Green and Red. When a candlestick is green, it means that the asset is bullish and there is a price increase. Conversely, a candlestick is red when an asset is bearish and there is a price decrease. Here are the components of a candlestick:
- Body: The body is the filled portion of the candlestick. It is the distance between the Open Price and the Close Price.
- Upper wick: The upper wick represents the high price of an asset over a period. The upper wick usually extends from the top of the body of a candlestick.
- Lower wick: The lower wick represents the low price of an asset over a period. It extends from the bottom of the body of a candlestick.
Main assumptions of technical analysis
Here are the three main assumptions of technical analysis:
- Price history is repetitive: This assumption entails that price movements are generally repetitive. Hence, you can use previous price trends to determine how future prices will turn out. Analysts take advantage of this assumption by reviewing the price trends of previous times and determining future prices based on what they analyzed. With this method, they can determine entry and exit points in the market by examining previous ones.
- The market discounts itself: The historical market prices of an asset are a reflection of the nature of that asset. By this assumption, you can observe that factors influencing the price of an asset are reflected in the asset’s price trend. This is the basis for general economics. For instance, if the demand for an asset increases because of good news associated with that asset, its price will increase as well. Here we can see the reflection of circumstance on the price of the said asset.
- Prices follow a trend: This assumption postulates that asset prices tend to follow a certain trend from their past prices to the current and future prices. The assumption can also be likened to the popular Newton’s first law of motion. In this case, the price of an asset continues in motion in a particular trend until it is reversed. A price trend could move up, down, or sideways.
How to do a technical analysis?
Here are the steps involved in technical analysis:
- Understand the trend: A price trend could go upwards, downwards, or sideways. You have to plan effective trading strategies depending on the price trend of an asset. Ensure that you read the charts and plan your trading strategies accordingly.
- Gauge the support and resistance levels: A support level is the lowest price point an asset reaches before more buyers come to increase its value. Conversely, a resistance level refers to the highest price point an asset reaches before it is sold and its value decreases. Gauging these levels can give you an insight into an entry and exit point.
- Use trading tools and indicators: Trading indicators are essential tools that help to predict future prices through the analysis of previous market trends. There are many indicators you can use depending on your trade. Apply the suitable one and get going with your technical analysis.
Technical analysis indicators
Indicators are important elements in technical analysis. They use quantitative strategies to predict an asset’s future price levels. Let’s take a look at some of the top technical analysis indicators.
They are composed of a simple moving average and two lines drawn at two standard deviations on both sides of the central moving average line. The band is made up of the outer lines.
In ranging markets, the Bollinger Bounce measures the movement of price bounce from either side of the band before returning to the moving average. The bands act as the dynamic support and resistance levels.
The Bollinger Squeeze helps time trade entry and catch breakouts early in trending markets.
As the bands squeeze, it shows signs of a breakout. However, the price could swing either way without hinting how it will move. In summary, Bollinger Bands indicate different markets— ranging and trending— using various formats (Bollinger Bounce and Bollinger Squeeze, respectively).
Relative Strength Index (RSI)
RSI is a momentum indicator that is plotted on a separate scale. The line scales from 0 to 100 and signifies overbought and oversold conditions in the market. Above 70 means an overbought market, while below 30 means an oversold market. RSI helps you pick tops and bottoms in the market as the trend reverses, so you can take advantage of the entire move. RSI can also be used for trend formations. E.g., if the RSI is above 50, the market might be in an uptrend. Alternately, if it’s below 50, the market is in a downtrend.
Depending on the risk management, you might want to wait for trend confirmation. You might make more profits by entering a trend early and potentially lose stop pips, or you wait for trend confirmation which makes you miss a portion of the move and potentially make lesser profits. Either way, the choice is yours.
Parabolic Stop and Reverse (SAR)
Parabolic SAR is a simple trend indicator in which dots are positioned above the chart or below the price and signal the potential direction of the price movement. A market in a downtrend is indicated with the dots above the price— which means that you should hold a short position. In an uptrend, the dots are below the price, which indicates that you should be in a long position.
It is worthy to note that Parabolic SAR should not be used in a ranging market when prices are moving sideways. The dots will move from side to side, leaving a confusing signal.
Average Directional Index (ADX)
ADX values range from 0 to 100 and are used to give trend strength signals. Weak trends are indicated with ADX below 20, while strong trends are indicated with ADX above 50. ADX doesn’t tell you the trend direction, only trend strength. ADX can help you avoid fakeouts when trading and is best used with other indicators as it doesn’t provide trend direction signals.
It also helps exit trades when trends are weak to avoid price retracements. Like many trend indicators, ADX is slow on price, so it’s useless if you want to enter trends early. However, it is beneficial for trading strong trends.
These are two horizontal lines based on Fibonacci numbers indicating support and resistance levels. Every level displays a percentage that indicates how the price has retraced in a previous move. The retracement levels are based on Fibonacci ratios like 23.6%, 38.2%, 61.8% and 78.6%.
Limitations of technical analysis
Critics argue that price trends are not always the same from the past to the future. Many factors may affect price movement at any period that may be beyond conventional control. Hence, this may cause a shift in perspective of the assumption that price trends repeat themselves.
Another limitation is that technical analysis may be accurate in some cases but only so because of a self-fulfilling prophecy. Some assumptions are proven to be true because of certain actions taken by investors. These actions may propel the market to meet the assumptions. For instance, if many investors use the same signal, a collective action might be taken in the market to cause an inevitable change in the price of an asset.
Does technical analysis work on crypto?
Technical analysis is used across various assets, especially in the stock market. But one might wonder if it can be applied to crypto. The nascency of crypto is a leading cause of this burning question. However, technical analysis can indeed be used on crypto. The volatile nature of crypto can be analyzed to make certain decisions for future assets. Investors may also receive a signal on entry and exit points in the market. Proper crypto technical analysis helps to curtail risks in your investment. With the complexity of crypto assets, technical analysis may come in handy.