What is Technical Analysis
Technical analysis is the statistical and mathematical analysis of the rate of quotes or cryptocurrencies with a view to forecast their future prices. Using technical analysis, traders determine when to buy or sell assets on an exchange. Their determinations are based not on stocks or cryptocurrencies themselves, but price movements.
This type of analysis uses a series of charts displayed on trading platforms. The graphs accurately show the direction of a price movement, or a so-called trend, in real-time. Most small and medium-sized players in financial markets operate based on technical analysis.
The basics of technical analysis
Technical analysis is based on three assumptions:
Market movement takes everything into account – technical analysts believe that all factors that influence the price are already taken into account in supply and demand. Therefore, the reason why the price has risen or dropped is not important, only the price change itself matters.
Prices are moving directionally – prices don’t move chaotically but obey certain laws. The task of a trader is to recognize the trend in time and use it. Technical analysts believe that a trend is likely to continue to develop in the same direction until signs of a reversal appear. Technical analysts determine the direction of a current trend by changing the highs and lows of the price. Consistently rising highs and lows indicate a bull market, when prices or the entire market has been rising for a long time. Consistently lowering lows and highs indicate a bear market, when prices or the entire market drops for a long time. Lows or highs that are approximately at the same level indicate a horizontal trend. This means that prices are relatively stable and there is no clear decrease or increase. Such periods are also called “flat”.
History repeats itself – cryptocurrencies and stocks are traded by people and they tend to behave similarly in certain situations, which creates cycles of repetition in a market.
Basic methods of technical analysis
Technical analysts study prices on charts, and they also use indicators and oscillators. They combine different technical analysis tools with each other.
Mathematical analysis
The main tools of mathematical analysis are indicators and oscillators.
Indicators track the beginning of a trend, its end and its reversal. They help traders to spot a new trend and join it.
Oscillators are indicators of fluctuations. They work when there is no pronounced trend in the market. Oscillators help identify overbought or oversold financial assets. Most often, traders track the difference between the oscillator and the price chart, which is called divergence.
Japanese candlestick
This type of graphic analysis was invented by a Japanese rice trader in the 17th century and is now one of the most common methods for displaying market data. A candlestick divides time into periods. Such a division into periods makes the overall picture more clear and helps to understand a trend and changes better. Here, the red and green rectangles are colored depending on whether the opening price was lower than the closing price of the period or vice versa.
Each candle has a line similar to the candle wick. In practice, the relative length of the wicks can be used to judge the trend for the next period. The long upper part of the wick (compared to the bottom) may indicate further growth, and the longer lower part, a fall.
Price action
The price action relies on the basic concepts of technical analysis – support and resistance levels, double or triple tops and bottoms, false and true breakouts, etc. In this method, analysts do not use indicators, because they believe that all indicators are late. Traders make forecasts only according to price charts. They analyze supply and demand, current trends and candlestick patterns.
The main figures of technical analysis
Simple figures are the most accessible patterns used in technical analysis. They are based on easily determined patterns of movement of cryptocurrency quotes and describe the change in the price of a crypto-tool.
Based on repeating and similar to each other figures, you can learn to make predictions about future price movements.
Head and Shoulders
The head and shoulders reversal pattern is quite common after a strong and long-term trend. The figure is three consecutive peaks, the middle of which (the head) is the highest, and the other two peaks on the sides (shoulders) are lower and approximately equal.
Double Top and Double Bottom
A double top is formed during an upward trend. The price rises and then goes down from a certain level (the first peak) and drops slightly, forming a local minimum – a signal line. Then the price rises again to the level of the first maximum, forming the second peak and goes down again. The price can then continue to fall, changing to a downtrend.
A double bottom is one of the most common figures that occur after a downtrend. As a rule, a classic double bottom portends at least a small change in the direction of the trend. The main price movement, which confirms the double bottom is considered the intersection of the resistance line from the bottom up.
Rectangle
A Rectangle is easy to spot on the chart. A rectangle is a kind of pause in a trend, during which the number of buyers and sellers is approximately equal. The distinguishing features of a rectangle are smooth support and resistance lines placed horizontally, creating an imaginary rectangle.
The rectangle is a simple figure in technical analysis that demonstrates the struggle between sellers and buyers and it is not clear which of the players will win this “battle”.
Flag and Pennant
The flag and pennant reflect a short period of consolidation as part of a dynamically developing price trend. The formation of such models is preceded by a sharp change in prices. The consolidation pattern itself is limited by support and resistance lines that parallel or slightly converge, forming a figure similar to a flag. The flig is tilted to the side opposite to the direction of a trend, or located horizontally.
When the trend breaks, the price movement should repeat the distance covered before the formation of this figure.
Wedge
A wedge is an up or down figure with a triangle shape. There are two variations of the pattern:
1) an ascending wedge – with growing lows and highs;
2) a falling wedge – with falling lows and highs.
It can be either a trend continuation pattern or a reversal formation. One key point to remember is that a wedge trend will break if the price moves in the complete opposite direction.
The most popular indicators
Technical indicators are the visual representations of mathematical calculations using certain formulas that calculate past price changes or other market data. The role of indicators is to simplify the analysis of the huge amount of information presented on price charts. A trader needs to know how to correctly interpret chart indicators to be able to identify reliable trading signals for buying and selling.
Moving Average (MA)
Most of the simple strategies based on technical analysis are somehow related to the moving average indicator. The moving average will give you the average price movement over a certain time frame. As the rate changes, the value rises or falls, which allows you to determine where the cryptocurrency is headed in the future and profit off of it. The rules for using the moving average are quite simple: if the price is above the moving average, then the price will rise, if lower, then it will fall.
Stochastic Oscillator
Another popular oscillator is the Stochastic Oscillator. It consists of two lines, one of which shows the ratio of the current price to previous values for a certain period, and the other is the first moving average.
The main idea of this indicator is that it shows the fluctuations between the maximum and minimum. Based on information received from the indicator, a trader can determine where the price is currently located.
It is convenient to use the oscillator as a filter for a trend indicator and filter out false signals, however, trading on the Stochastic Oscillator alone can lead to negative dynamics and losses.
Relative Strength Index (RSI)
The RSI indicator shows how much the market is overbought or oversold at a given moment. It is a good tool and gives clear signals in most market situations. That is why it is considered one of the best counter-trend indicators out there.
Relative Strength Index (RSI) is in many ways similar to Stochastic, however its fluctuations within the ranges are calmer and signals are rarer. In addition, this indicator consists of one line, and does not have its own MA.
Average Directional Index (ADX)
The ADX indicator is a very popular trend indicator among traders. The indicator does not show a trend’s direction, but rather a trend’s value. For example, the price on the chart may fall, while the curve of the indicator will rise. In this case, the indicator is showing that the trend is strong.
This indicator can be interpreted as follows:
- If the value of a growing curve is above 15 then there’s a trend;
- A value above 30 shows a stable trend;
- A value above 40 shows a strong trend;
- If a trend curve reverses downward any level, we can say that the market is entering a phase of sideways movement.
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