Introduction to Technical Analysis
If you want to become a successful trader in the cryptocurrency market or any other market, it is important that you understand technical analysis. In this guide, you will learn the basics of technical analysis and how each element of the technical analysis is essential to your success.
What is technical analysis?
At the very basic level, we can say that technical analysis is the use of price chart and other elements to make an investment decision. It other words, as a trader or investor, technical analysis helps you get the “bigger picture” on an investment price history. So, you can forecast when the market will bearish or bullish and make an informed decision when trading.
Common technical analysis myths
You may not think that something so innocuous would be so polarized, but it is, many cryptocurrency traders often denounce its value, while others are staunch supporters. Here are some common myths and the truth about these myths.
Technical analysis is simply for short term trader: One common misconception is that technical analysis is only useful for computer driven short term trading, but this argument is utterly flawed.
Technical analysis is a way of determining high probability setup in reaction to your market, so it gives you a clue about a market move; not just on a day to day trading, but also for the next one week or one month.
Besides, technical analysis was used long before short term trading emerged and computers have only come to make it more efficient.
Technical analysis is all about reading charts: It is not about reading charts, but also about interpreting the psychology of markets and make an informed decision. Typically, a trader observes the market behavior observations and calculated predictions on the future outcome.
Fundamental analysis is better than technical analysis: Most traders believe that fundamental analysis is better than technical analysis. The reason for this is because fundamental analysis has always been considered the cornerstone of the business.
But as a trading concept fundamental analysis does not offer the same benefits that the technical analysis. Technical analysis plays significant roles in making trading decisions; it acts as a valuable data point and an important strategy in an investment process.
Only individual traders utilize technical analysis: Most people often think that you can only use technical analysis as an individual. But this is contrary from the truth, big hedge fund, and investment banks and other corporation makes abundant use of technical analysis.
Technical Analysis vs Fundamental Analysis
Technical and fundamental analyses are the two techniques used to analyze a market before making a trading investment decision. Both use different methodologies that can allow you as an investor to predict movements in the market and ultimately helping an investor make a good decision, but they both have their advocates and adversaries.
As we’ve mentioned, technical analysis tends to look at the price movement of a coin or an asset and use the obtained data to predict future price movements.
Fundamental analysis is different; it looks at the economic, industry and financial data and factors that influence a business. But that’s not all, let dive into details about the two approaches
Fundamental analysis uses a long term approach to investing compared to technical analysis. Don’t get me wrong, technical analysis can be used to predict the cryptocurrency and stock charts and predict the price movement in weeks, days or minutes, however, the fundamental analysis looks for data that spans multiple quarters or years.
Thus, an investor or a trader using fundamental analysis will have to wait long before a company intrinsic value is realized. The investor will have to rely on a financial statement that is filed quarterly and changes in earning per share something that does not emerge on a daily basis.
Generally, technical analysis involves analyzing charts, which has data from a short period. Technical analyst will not measure the security’s intrinsic value instead, they will use the price charts to identify the pattern and make an informed decision.
A fundamental analyst, on the other hand, will measure the company value by discounting the value of projected cash flow, so a security price that trades below that value is considered a good investment opportunity or vice versa.
There is no scope for looking out past trend of an asset when it comes to fundamental analysis. But technical analyst will assume that the past trend of a coin, for instance, is repetitive and the current movement can be used to predict a future trend.
So, regardless of whether you are trading stocks or cryptocurrency, there a given cycle that will occur time, again and again, all you need is a tool that will compare different price movement.
Value of the asset
A technical analyst believes that no real value can be realized to any asset, thus price depend on the demand and supply forces and therefore controlled by rational and irrational factors from traders.
On the contrary, a fundamental analyst will estimate the asses intrinsic value and purchase it when the price is less this value and sells it when its more to earn profits.
What are charts?
When doing technical analysis, trader relies on charts to predict the ideal entry or exit points for a trade. Charts are a graphical representation of the price of the assets over time. Using chart is so important that technical analyst terms them as chartists.
Before technological advancement, charts were drawn manually, and it was quite hard to have an accurate analysis in the shortest time possible.The main charts use by technical analysts are bar charts, candle sticks chart, line charts, and point-and-figure charts.
The type of charts uses depends upon the information the technical analyst considers critical to the market.
The most basic type of chart is a line chart; it represents the closing price over a set period of time. The line will be formed when connecting the closing price for each period over a certain timeframe.
Although the chart provides detailed insights into the intraday price movements, traders often consider the closing point important that the opening price within a set period of time.
The good thing about the line chart is that you can easily spot trends because there is no much noise compared to other types of charts.
The bar chart is the basic tool used in technical analysis. A bar will expand the line charts by having an open, high, low and close price range.
The chart will be made up of a number of vertical lines with a different price range for a given period with a horizontal dash on each side representing the close and opening prices.
The price on the horizontal dash on the left side is the opening price and the closing price is on the left side. If the opening price is lower, the line is shaded to represent a rising period.
Candlestick originated from Japan, but they are extremely popular among traders. Pretty much like the bar chard, candlesticks have thing vertical lines with a price range for a period.
The bar is shaded on a different color depending on whether an asset ended lower or higher. The big difference will be represented by a wide rectangular. Falling period often has a red or black while the rising period has a white candlestick body.
Point and figure
These are not popular especially to the average traders but they have been used for years. The point and figure chart basically reflect the price movement but without time concerns like other types of charts. This removes the insignificant price movement that can distort a trader view an about the overall trend.
What are trends?
Trends are divided into three types, the uptrend, downtrend and sideways/horizontal trend. I’ll show you each trend on a single Bitcoin’s chart for the past year.
Uptrend provides an investor a chance to profit from an asset until it reverses. Typically, when an asset is making high and higher lows, the asset will be considered an uptrend.
Such a movement indicates that the security or an asset being traded is making a consecutive peach that what was high. When a stock or the asset is an uptrend, the trader should by on dip hoping that it will rise further.
Many traders try as much as they can to avoid downtrend because they tend to affect the overall value of the investment. Generally, a downtrend will occur when an asset is making lower highs and lower lows over a period.
Lower highs imply that the previous peak was higher that it is, while low means that the present bottom is lower than the previous one. So, you are trading a digital asset like bitcoin and it’s showing a downtrend, then you need to sell on bounces since there are chances that the asset could fall even further.
Sideway trends are also termed as horizontal movement. It occurs when supply and demands forces are almost equal. They are generally because of price movement between competing levels of resistance and support, so it is very rare to see a horizontal trend dominating the price action on an asset for a long time prior to starting a new trend.
Support & Resistance
It is very common to hear technical analysts talking about bull and bear or a battle between the buyers and sellers. These terms generally refer to price levels that prevent the price of an asset to be pushed in a certain direction.
Support is considered the price level where the amount of trader willing to buy the coins are high or the downtrend pauses because of demand concentration.
Those traders will believe that the currency is low at this level and will seek to purchase it at that price. So, if you trading a coin, the very moment the coin reaches that level, a ‘floor’ of buyers is created and price drops. When the price drop, the demand increase forming a support line.
At the same time, the resistance zone rises due to the sell-off when price increases.
Support and resistance levels are important levels, and knowledge of these levels could keep a trader on the right side of the market. As price reaches a certain value say 50, 100, 150, 1050, people will see these levels as the strong potential that can interrupt in the current movement.
The price could hit the line or even reverse, or it could hover around the levels for supremacy or could punch straight through, so as a trader, it is important to exercise caution when approaching the said levels.
So far, the only thing we have discussed when it comes to technical analysis is the price, but volume is also an important factor in technical analysis especially when it comes to cryptocurrency.
Volume is basically the measure of how much a coin has been traded over a given time in a day. It is a power tool but often overlooked because of its simplicity.
Why is it important? Technical analyst will use it to confirm trends and patterns. In particular, volume increases each time a buyer or a seller transact so for instance, is bitcoin enjoys a very long uptrend and then declines in one trading day, it is worth to check out the volume in order to get the overall picture of whether the movement represents a new trends or just a temporary pullback.
Being able to know when the price will increase or reduce has a strong support of knowing when buyers or seller have been exhausted and this could be very useful when you are trading. So, when a coin goes down, it could be a good idea to the volume associate with the decline.
Using technical analysis you can identify a trend as well as market sentiments and make good investment decisions. It is indeed a practical method to weigh to past the price of the coin and their trading volumes.
However, when you are entering into a trade, it is not a good idea to entirely rely on technical analysis especially when it comes to cyptocurrency.
Technical analysis generally ignores the new and other fundamental factors such as the regulations, mining hash, ETF certificated and so forth. Technical analysis may not predict these aspects, so it could be a wise thing to mix with fundamental analysis.