What is technical analysis crypto

Brief summary

• Technical analysis means reading and analyzing candlestick patterns and indicators

• In fundamental analysis, you make an overall picture of a cryptocurrency

• The goal of technical analysis is to beat the market

• By using technical analysis you stand a good chance of being the first to see what the market is going to do

• Indicators show the price development of a coin in a chart

• Visual patterns indicate when something unusual happens in a candlestick pattern

• Technical analysis has its limitations, but there are also opportunities

• Technical analysis is very important in day trading and swing trading

• Technical analysis is an indispensable tool for serious traders

Technical analysis: the basics

Since the subject is too extensive to write it out in one go, we have divided it into several parts. This section is the general part, where we tell what it is. In other parts we will go deeper into candlestick patterns and indicators.

Technical analysis: Candlestick patterns and indicators

Definition:

Technical analysis is the study of graphs of historical series of prices, such as of crypto or stocks, combined with historical information from the market, such as price and volume, to make statements about future rates in the short term.

So, that's quite a mouthful. So it boils down to interpreting past prices in such a way that you have a good idea which way a price is going. That is of course very important if you decide to make a cryptocurrency buy or sell.

Candlestick patterns

Technical analysis is quite old. Candlestick patterns have been studied since the 18th century. The origin is Japan, where Munehisa Homma studied the patterns in the rice market to buy or sell rice. For this reason, they are also called Japanese candles.

Technical analysis is a part of mass psychology, where human behavior is the basis for getting an indication of the near future regarding the price of a cryptocurrency. The market cycle is the outcome of this.

Components of a candlestick

By the way, a candlestick consists of the starting price, the ending price and the wicks per given period. If the candle is green it is because the ending price is higher than the starting price and a red one vice versa. The candle itself consists only of the opening and closing prices. The wicks indicate the extremes during that period. Thus, you will then see a candle with a dash at the top and bottom representing the highest and lowest price.

Technical analysis and fundamental analysis

Technical analysis (TA) is the counterpart of fundamental analysis. In fundamental analysis (FA), every aspect of a cryptocurrency is considered to get an idea of the possible price trend in the future.

FA addresses issues such as total stock, roadmap, usability of the technology, cost, competition, et cetera. For example, a cryptocurrency that is widely used if traded heavily will have a high probability of becoming more valuable in a bull market based on FA.

In TA, you are analyzing a number of factors specific to the cryptocurrency you are researching. The price is the leading factor here.

The purpose of technical analysis

The main purpose of technical analysis is to make important decisions when buying and selling cryptocurrency based on objective information from unbiased sources.

The ultimate goal of technical analysis is to do better than the average market player. Often targets are set and a division is made at which price level profits are taken or losses are taken. After closing the trade, it is the next TA's turn for a new prediction.

Skeptics on technical analysis

There is considerable consensus among scientists toward technical analysis. They believe that all market factors are already incorporated into the price. It is sometimes claimed that it is more of an art than a science. Well, then we become artists, don't we?

Selffulfilling prophecy technical analysis

Yet there is a "catch" here. If you start doing technical analysis and you have to buy (or sell) according to TA, it is more than likely that you are not the only one who comes to that conclusion, making it a selffulfilling prophecy.

If all technical analysts buy at the same time, of course the price goes up. Perhaps it is not a science. But if your prediction based on TA is correct you can make money from it. Those who do TA also have the advantage of being the first to act. Those who don't do TA don't see the market movement until later.

This is easy to check by, for example, opening the MACD in TradingView and looking at the BTC-USD chart at the historical price movements to see if Bitcoin is indeed rising or falling when crossing lines (often it is).

Main forms of technical analysis

1. Visual analysis of price patterns and trends. One is looking for recognizable patterns in the candlesticks. Candlestick patterns indicate the price of a cryptocurrency in a given period. A green candle means that the price has risen in that period (hour, day or chosen by yourself, according to your needs) and a red one that it has fallen. Well-known patterns like (inverse) head and shoulders, descending and ascending triangle, falling and rising wedge, double top or bottom are patterns that call for an action when using visual TA. In the bullish pattern this means a buy, in the other case a sell, according to the meaning of the different patterns. Some people also take action when a single candlestick, such as a hammer, appears in the picture, but most TA fanatics wait for confirmation of the pattern via multiple candles.

2. The second main form is called the quantitative analysis. This involves the use of various indicators. An indicator is a formula applied to stock prices, with the results providing buy and sell signals.

Resistance and support

A common method used in the visual technical analysis is to establish resistance and support. When there is resistance, you can see that a cryptocurrency shows an upward trend until a certain price, then it stops growing. The most logical explanation for this is that traders start selling around this price, creating downward pressure on the price. So they take their profits around that price and this little game can go on until these traders have sold all their crypto. Only then can the resistance be broken.

The other side of this story is support. Here the opposite happens. If there is a downward trend where the coin becomes worth less, but stops dropping at a certain price, there are plenty of traders who buy the coin at this price, so the price should go up again.

What is bandwidth in technical analysis?

Resistance and support together form the bandwidth, which a cryptocurrency moves between in a given time period. What you often see is that when the resistance or support is broken that the former resistance now becomes a support and the support now becomes a resistance. It is also more common that one more pullback follows the support or resistance. This is called a pull back and is an additional opportunity for traders to get in or out.

In principle, anyone can use this method. If you ever look at the price movements of a coin per day you'll often see the resistance and support on your screen. With a bit of skill and trial and error, you can get a long way with this simple method if you want to use it when trading.

What is backtesting in technical analysis?

At the quantitative analysis you can use backtesting of the indicator to see what results it would have produced in the past. In backtesting, you use an indicator and apply it to a period in the past to see what results you would have had if you had worked with this indicator. Did Bitcoin go up when there was a crossing of lines at the MACD, for example.

Since crypto is very volatile and special market conditions such as bull and bear markets occur more often, it might be useful to backtest for a specific time period, say last bull market. Indeed, if you are in a bull market, it is quite inconvenient to see how an indicator did in a bear market. You should exclude that period then.

What are technical indicators?

Technical indicators are used in quantitative analysis. We will briefly discuss the most popular ones because traders working with TA have more influence on price when using them than if they follow a little-used indicator.

A technical indicator consists of data from the price development of a cryptocurrency. These are displayed in a chart and at certain values have not only a signaling function, but also a predictive one. According to experts, a combination of several indicators is the most reliable.

Variants of indicators

There are basically three variants: directional indicators, such as Relative Strength Index (RSI), trend following indicators, such as Moving Average (MA) and oscillators (indicates momentum of two moving averages) as Moving Average Convergence Divergence (MACD).

Relative Strength Index

The Relative Strength Index is very widely used because it gives important and simple signals. Its value fluctuates between 0 and 100. Above 50 is a positive signal for price movement and below 50 is a signal that the price may fall. However, the most important signal is when the RSI is below 30 or above 70. At 30 or below, a coin is oversold, so this is a buy signal. At 70 or above, it is overbought and is a sell signal.

Moving Average

Moving Average is a fairly simple tool to display the trend of a cryptocurrency. Because of its simplicity, it is often used. It involves a line that represents the price per day and as time progresses it shows a clear direction where the price is moving. Commonly used moving averages are 200 day MA and 50 day MA. Often these two lines are crossed to indicate a trend reversal. Since these lines cross infrequently, it is both a very strong signal and something that occurs infrequently and therefore should be used in conjunction with other indicators.

MACD

Moving Average Convergence Divergence gives buy and sell signals and is therefore quite popular. This involves taking multiple moving averages and determining momentum. MACD works with the MACD line, the signal line and volumes. So it is already a bit more complicated than the other two. If the signal line crosses the MACD line then that is a buy or sell signal. Frequently used are the 12 and 26 day lines.

Other commonly used indicators are:

• Fibonacci indicator

• Bollinger Bands

• Ichimoku Cloud

Candlestick patterns and indicators require a complete study if you want to excel in them. Still, it doesn't hurt to take a look at the most popular ones and see with backtesting what it would have gotten you.

What is a trading system in technical analysis?

When several indicators are used simultaneously it is called a trading system. After considerable testing, you can use such a system in the market. The tricky thing about a trading system is that you have to rely on it pretty much blindly, even if your gut feeling tells you not to do it. The system only works when you apply it for a longer period of time.

Using one indicator is hard enough. If you want to apply several, you run the risk of not seeing the forest for the trees. Therefore, this is only recommended for experts and mathematicians. Anyway, if it works for you, you should do it this way.

Which indicator(s) provide the best results?

There are quite a few indicators out there. It is up to the trader to find the indicator(s) that will give him the best results in TA. Logically, the most popular indicators have a greater chance of producing good results. If many people use a particular indicator and according to that indicator you should buy now, then most will actually buy. If enough traders do, the price goes up. Therefore, in TA it is smart to work primarily with the most widely used indicators, even though your preference may be for the more obscure varieties.

Ultimately, it is about results. This should be systematically tested, even after one is already using an indicator. There is always room for improvement, so a round of optimization can't hurt. If you write down in advance at which price ranges you are going to buy or sell, this works best.

Using indicators in TradingView

The most widely used site for using indicators is TradingView. Here you will not only find most of the indicators, but everything is also displayed in a nice big picture. Optionally, you can use other apps if you find TradingView a bit too punishing. You can also work "dry" with TA via TradingView for a while, to see if what you come up with had the effect that should have followed according to your technical analysis, without putting money in. By looking at a popular indicator, you can immediately see if the price has changed based on an indicator's signals. If so, then it might be a good idea to use the ones that gave a clear signal that followed the market.

Visual patterns

If a pattern is very recognizable and has a certain meaning, it may very well be that there are many traders who see such a pattern as a strong signal. If they then take action, that pattern gets a powerful effect.

• Head and shoulders. This is the best-known pattern. Everyone knows what a head and shoulders looks like. In a chart, you then see that a cryptocurrency forms a pattern with three peaks, with the middle one being by far the highest and the two others similar in height. This is a classic bearish pattern, where the price is likely to fall solidly, since the pattern is recognizable to anyone looking at it and calls for action. The reverse head and shoulders means the opposite. By far the most important coin followed in this is Bitcoin, the market leader. In explanatory terms, you see that a coin first rises sharply, then falls back a bit before making a big spike. Since the third peak is a lot lower, traders assume that from then on the price starts to fall.

• Head and shoulders is a pattern that is part of a collection, where two straight lines can be drawn in a chart. Other members of this group are the bearish and bullish flag, double top and double bottom and the triple top and triple bottom. When you see such a pattern become visible within a certain range it signals that something is about to happen. It is going too far to explain all this exactly in this Academy article, we promise to do so in another article.

• Another common group of patterns consists of a triangle that you can draw in a chart. Common visual patterns are the descending and ascending triangle, rising and falling wedge, bearish and bullish wedge and the symmetrical triangles.

If these visual patterns occur it may well be that traders doing TA are trading on this basis and action follows that has a significant impact on price. Especially if these patterns are seen in the chart of Bitcoin, which has by far the most influence on the price of all coins.

Visual analysis using apps

Since visual analysis is by far the simplest method and you actually need to keep an eye on Bitcoin in particular for the big trend reversals, a brief study of candlestick patterns can already tell you a lot about the future, such as when the end of the bull market is coming or when it is just starting. In the past bull markets, you can recognize Bitcoin's head and shoulders pattern quite easily if you go into the max chart of Bitcoin at CoinGecko.

Nowadays, there are all kinds of apps and software on the market that automatically give you signals if any of the indicators contain an important pattern. Algorithms go to work for you to find them for you and alert you. That already saves a lot of work. All you have to do then is look carefully at the signal and decide for yourself whether to take action based on such an alert.

Limitations of technical analysis

Unfortunately for our fierce researchers, there is also such a thing as the world outside the chart. You can go blind on a MACD or RSI, but if the coin you are studying disappears from the list tomorrow on a major exchange, the price could drop significantly. Or it might just get put on there and the price explodes.

If there are important macro economic events in the world, such as Covid or a war, this can depress prices significantly.

If there is a sudden explosion of Bitcoin ETFs or from Ethereum, then the price could go through the roof.

Is something not right about an important smart contract, then a cryptocurrency can completely collapse, as we have seen with Terra Luna.

Signals that yield nothing

What can also just happen is that a cryptocurrency does not care at all that it is oversold or that there is a golden cross. Usually there is a special reason for this, such as hype or meme coin mania.

If you notice more often that obvious signals from your favorite TA instruments are barely getting you anywhere, it's time for an analysis. Perhaps you are using the wrong instruments or certain instruments do not work on your favorite coins for whatever reason. Since it is an art rather than a science the saying: practice makes perfect.

Being in the zone and overseeing the whole

Another limitation is how much overview you actually get with an indicator. For example, it may well be that the trend has been upward for some time, but in low volume. As soon as the volumes increase the price suddenly drops. If this is not accounted for in the chart, you may be working uselessly, because large volumes have much more influence than smaller ones and are a good indicator of a trend.

Another limitation is the composition of your portfolio. If you only have AI coins and the hype has died down, the total value can plummet quickly, even if you have studied trends and candles so hard! Diversification is an important part.

Technical analysis in trading

When using technical analysis when trading, a whole world can open up to you. It is used in many ways to trade just a little more precisely. We won't reproduce the entire study here, but highlight a few possibilities.

• Day trading. In day trading you work with TA in a very short term trend. When you look at a chart you pay attention to the 1 minute, 5 minutes or 15 minutes timeframe. The purpose of day trading is to make small margins and to include very small losses. Very important here are the candlesticks and so you'll have to become an expert in these. If you know the most important patterns by heart, taking action will be a lot easier. If you see a head and shoulders, a shooting star or a double top, you'll know exactly what to do. Even single candles, such as a hammer, can be a signal. Most commonly used in day trading are margins of around 2-3% profit and around 1% loss. That way you "only" have to be right 1 out of 3-4 times to be on the right track. Indicators are only indirectly useful because their function is mainly longer-term. Day trading is for people with a lot of time or experts who learn daily. In day trading it is essential to keep transaction costs within limits, otherwise it is a pointless activity.

• Swing trading. This usually involves using the daily price chart. Indicators are frequently used to observe certain events that predict a price drop or rise as a guide for trading. Indicators tend to pick up just a little too late or just a little too early. Again, experience is key. Often a moving average of, say, 50 and 200 days is used. If these cross, there is a buy or sell signal, such as a golden cross. Confirmation is usually sought in other indicators, such as RSI or MACD. Trading volumes are also looked at to see if a significant move is imminent. With swing trading the margins are a lot bigger, because you also have to wait longer. A swing trade has a time horizon of days to weeks. So you can think about it long enough. Essential are the bandwidths, which are easy to spot. If a coin is regularly bought at 1 euro (support) and sold at 1.25 euro (resistance), you can grab a considerable margin if this pattern is repeated. Especially in sideways trends you can still make profits. With a breakout through support or resistance, a bandwidth will have to be determined again when swing trading. Day trading and swing trading are very difficult and a lot of money is lost, especially by inexperienced traders. It just takes a lot of practice.

• Investing. Here fundamental analysis is much more important than technical analysis. If you are going to invest in a particular cryptocurrency, you do so because you know a lot about a coin and its function and assume that as time goes on it will automatically become more valuable in the right market conditions. For example, everyone knows how important Ethereum is in the world of smart contracts and apps. So at the beginning of a bull market, you can invest in such a cryptocurrency, because you know that Ethereum will be used a lot then and therefore will increase in value. This is because there is then a lot of demand for the coin and this is a bullish sign. Here technical analysis can still be used to indicate the most favorable purchase price approximately. After that you don't really have to do anything except determine when you think the bull market is over and then sell. There are several cryptocurrencies that are widely used in a bull market, such as oracles, DeFi coins, layer2 bridges, et cetera. This is because there is much more trading during bull markets.

What do you get out of technical analysis?

When you hear all this it seems like a lot of work. But actually it's not so bad. For example, you can look at an indicator to look for a crossing of lines determined by day or an overbought coin. At a glance you can see if a line crosses or if the RSI is above 70. If you do that once a day then you know that a change could be imminent. Indicators can be found in many places.

If you look at an indicator and look back in time at historical prices you will suddenly see at certain lines that cross in the past large volumes and a firm price action on the same day or right after. Then you know that people bought or sold based on that indicator. This is very useful information and can yield hefty profits, because with that indicator you are the first to know about the change, along with others who do TA. A matter of trying it out.

With certain forms of trading, such as day trading, you can't escape technical analysis. You have to know how candlesticks work. Remember that more people are engaging in TA and it's not just some candles in the wind. If you are increasingly right based on technical analysis you will eventually start to embrace TA and see it as an important tool that will give you better results.

We dare say without question that traders who do technical analysis will have better results. Are you going to use it too?