Shield Academy | Basics of Technical Analysis
As crypto trading becomes increasingly popular, so does the number of traders in the market. It is important for investors — both beginners and seasoned traders — to have a sound investment strategy in this scenario. And with the crypto market being extremely volatile, traders can make a lot of money on the resulting price fluctuations. However, relying solely on one’s intuition is never a great idea, and traders need to analyse the market constantly. Fortunately, tools like technical analysis have emerged as a great way to analyse the market and create the best crypto trading strategy.
In its simplest form, the technical analysis examines historical price and volume trends to forecast future asset price movements. It is performed using mathematical calculations known as “technical indicators” to examine and spot trends in an asset’s historical and present price and volume data. Popular technical indicators used by technical analysts include Moving Averages (MA), Relative Strength Index (RSI), Support and Resistance levels etc., all of which and more will be covered in detail in this article.
Basically, technical analysis is built on the premise that what has happened in the past can help us predict what will happen in the future by calculating odds. As a result, the next wave of investors will most likely follow the last wave’s trends. Given how human behaviour in markets is often predictable, comparing past volume and price patterns to current volume and price trends can reveal a lot about the possibility of future volume and price trends.
As a result, these can be plotted on a chart to get a quick and basic view of potential price pathways.
Similarly, technical analysis is also based on the notion that price changes are never random. Rather, these price changes are driven by short- or long-term patterns. Typically, when a cryptocurrency follows one trend, it almost always follows the opposite tendency as well. Therefore, traders can make profits by isolating these trends.
Unlike fundamental analysis, which looks at an asset’s fundamentals, technical analysis focuses on charting and employing technical indicators to better predict short-, medium-, and long-term patterns based on historical and present price and volume data. It’s important to realise that technical analysis isn’t about predicting what will or must happen. Instead, it’s about predicting future outcomes based on historical patterns.
If you’re just getting started with cryptocurrency trading, look no further. In this article, we’ve listed the most important tools for performing basic technical analysis so that you can improve your trading strategy.
Candlestick charts
Candlestick charts are the most popular type of chart that crypto traders use for technical analysis. They get their name from the fact that each plot point on the graph resembles a candlestick. They’re red (or pink) or green rectangles with a line coming out of the top or bottom, similar to a candle’s wick. The size and line of the candlestick, as well as the colour, reveal important information.
Each candlestick displays four critical components for the desired time frame. These are:
- Open price
The first price traded during the formation of a new candle is represented by the open price. If the price begins to rise, the candle will become green or blue (colours may vary depending on chart settings), and if the price falls, the candle will turn red.
- High price
The highest price traded throughout the period is indicated by the top of the upper wick/shadow. The absence of an upper wick/shadow indicates that the open or close price was the highest.
- Low price
The lowest price traded is either the price at the bottom of the lower wick/shadow or the closing price or open price in a bullish candle if there is no lower wick/shadow.
- Close price
The closing price is the most recent price transacted during the candle formation phase. If the close price is lower than the open price in most charting packages, the candle will turn red by default. The candle will be green/blue if the close price is higher than the open price (depends on the chart settings).
The interpretation of candlestick charts is fairly straightforward. The colour of the candlestick chart usually reflects the price direction. If the candle’s closing price is higher than its opening price, this signals that the price is rising and the candle is green (the colour of the candle may depend on chart settings). If the candle is red, it signifies the price fell below its opening level. Generally, candlestick patterns are separated into bullish and bearish patterns. While bullish patterns indicate a price increase, bearish patterns signal a fall in prices.
Support and resistance lines
Both support and resistance levels are horizontal lines that can be drawn on the trading chart to gain insights into the price performance of a crypto asset. These are typically the price levels that act as barriers to price movement, and they also act as indicators of the commencement of reversal trends.
The support level is the price at which traders are willing to buy large amounts of cryptocurrency. In other words, there is a lot of demand because traders believe the coin is undervalued. When the crypto asset approaches the support level, there will be a surge in demand, usually ending the downward trend. It can even change the momentum upward in rare circumstances.
In contrast, resistance is generated at a price level where currency holders are eager to lock in profits. They create a psychological ceiling or barrier for the currency’s price while the perception of its overvaluation grows. The market is most often saturated with sell orders at this point, which is aided by investors eager to enter short positions.
A breakout of support or resistance levels in your technical analysis most likely implies that the present trend is strengthening, and the trend may be strengthened even more if the resistance level turns into support. Traders should be warned, however, that false breakout might occur, in which case the trend would remain unchanged. Because of these factors, technical analysis necessitates the examination of several figures in order to identify trends.
Trend lines
Trend lines are similar to support and resistance levels, however, they are made up of diagonals rather than horizontal lines. As a result, their slope might be either positive or negative. In general, the stronger the trend, the steeper the line’s slope.
Trend lines are drawn from the highs and lows of a chart to show when the price briefly defied the main trend, tested it, and then returned to its favour. The line can then be stretched to try to forecast critical future levels. The trend line may be examined numerous times, but it is regarded as genuine only as long as it is not broken.
Generally, there are two types of trend lines: ascending (uptrend) and falling (downtrend) (downtrend). An uptrend line links two or more low points and is drawn from a lower to a higher chart position, whereas a downtrend line connects two or more high points and is drawn from a higher to a lower chart position.
Trade volumes
Traders can evaluate whether a trend is substantial or not by looking at the trading volume of a cryptocurrency. A high trading volume usually suggests a strong trend worth noting, whereas a low trade volume usually indicates a weak trend that will fade shortly. The volume of a market is generally viewed as an indicator of its strength since markets are typically rated as strong and healthy when the volume of the market is increasing.
Relative Strength Index
The Relative Strength Index (RSI) is a technical indicator generated from an asset’s price momentum. The asset’s price change and the rate at which it occurs are the most important components in calculating the RSI. These movements are referred to as oscillations because they can fluctuate dramatically between two extremes. The RSI oscillations are valued from 0 to 100. Generally, RSIs of 30 or less imply that the cryptocurrency is currently undervalued and that a price increase is likely, while an RSI above 70 indicates that the cryptocurrency is overbought, and its price may fall.
The RSI, on the other hand, may not be the most trustworthy indicator when it comes to BTC and other cryptocurrencies. BTC has shown that it is prone to long bull runs in which its price becomes, and often remains, overbought. Nonetheless, the RSI could prove useful in predicting when a retreat is imminent.
Moving Averages
The moving average (MA) is a fairly straightforward technical analysis tool that smooths out price data by calculating an average price that is constantly updated. The average is calculated over a set length of time, such as ten days, 20 minutes, 30 weeks, or any other time period selected by the trader.
The fundamental goal of a moving average is to level off a price chart by producing an average price data that is regularly updated. Any investor or trader can use this average to determine the trend direction of a certain cryptocurrency before or after investing. Moving averages are sometimes known as lagging indicators since they react to prior prices or create an analysis based on previous data.
The two most popular types of moving averages are Simple Moving Average (SMA) and Exponential Moving Average (EMA). The sensitivity of an exponential moving average (EMA) and a simple moving average (SMA) to changes in the data used in their calculation is the main distinction between them. More specifically, the EMA gives recent prices a higher weighting, whereas the SMA gives all values equal weighting.
Choosing time frames for technical analysis
It’s essential to remember that there is no perfect time frame for any asset at any one time in terms of technical analysis. While larger time frames are often regarded as more significant, this does not rule out the possibility of finding profitable trades on shorter timeframes. Checking different periods and evaluating trade opportunities is the ideal thing to do.
Typically, traders select the timeframe they wish to study according to their own trading style. Intra-day or short-term traders typically open and close positions inside a single trading day. Traders that fall into this category should limit their charting to short time frames, such as the 5-minute or 15-minute charts.
On the other hand, long-term traders who maintain market positions overnight and for extended periods of time are more likely to use hourly, 4-hour, daily, or even weekly charts to assess markets.
Conclusion: The best way to perform technical analysis
Without a doubt, technical analysis is an excellent tool for investors to get insight into a cryptocurrency’s past prices and make future predictions. In addition, most modern charting software comes with a number of pre-built analysis tools that traders can use to supplement their own research.
Relying entirely on technical analysis is never a good idea when trading cryptocurrencies because a single analytical approach provides limited information. Furthermore, focusing entirely on technical analysis will not provide insight into sentiment or news, both of which are components of fundamental analysis. This is especially problematic in cryptocurrency trading because factors such as mining hash and regulations can have a major impact on a coin’s price, but technical analysis ignores them.
As a result, combining technical analysis with other methods, such as fundamental analysis, is always recommended for the best results. Combining technical analysis with fundamental analysis gives traders the best of both worlds. A combination of both these methods essentially relies on both past and present information, thereby adding more value when it comes to mitigating risks.
Finally, traders, particularly newcomers, must recognise that there is no one-size-fits-all approach to investing in cryptocurrencies. Traders must determine which technique or method resonates with them, and the only way to do so is to investigate and learn about a few options. And once they’ve mastered various tools and actions that can help them enhance their trade, traders can even develop their own investing strategy based on learning and experience.
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