Definition

Technical analysis use historical price data and various analytical tools to identify statistical trends and make profitable trades.

Understanding Technical Analysis (TA) in crypto

Technical analysis (TA) uses statistical trends collected from historical price data to identify opportunities for profitable short-term trades. TA has been widely used in traditional investing, and the approach in crypto remains the same.

At its core, technical analysis is just basic economics wrapped in complex and technical sounding terms – it’s the essentially the study of supply, demand and price movements to predict trends and make a profit over an investment both rising or falling in value.

Technical Analysis vs Fundamental Analysis

While fundamental analysis looks at dozens of variables which help determine an asset’s long-term ‘intrinsic value’, TA is focused on the charts and its numerical data, concerning itself strictly with ‘WHAT’ happens to an asset’s price, rather than ‘WHY’ it happens.

Instead of using factors like a cryptocurrency’s utility in the current market, the strength of a project’s community, team & partnerships, TA uses a variety of technical indicators like moving averages, trendlines, Relative Strength Index (RSI), etc. Which is why most newcomers and long-term investors tend to lean towards fundamental analysis (a combination of TA and FA is the ideal strategy).

Core principles of technical analysis

Technical analysis works on the principle that:

• Movements in price are not ever random but the result of certain short or long-term trends which can be identified & isolated to make a profit.
• History tends to get repeated. It is possible to predict market psychology. Traders sometimes react the same way when presented with similar stimuli.
• ‘What’ is more important than ‘Why’ – TA is concerned with the price of a coin (supply & demand) rather than the dozens of variables that influence its price

Different charts for technical analysis:

TA relies predominantly on gaining its information from different charts, including:

• Candlestick charts
• Bar charts
• Line charts

Each chart can have similar data but can present the information in different, useful ways, allowing traders to identify trends that can inform their investment decisions.

What are some key technical indicators:

TA incorporates a variety of factors and technical indicators garnered from charts such as candlestick, bar and line charts. Some of the most common technical indicators are:

• Market Cap – A simple indicator of a cryptocurrency’s stability, risk profile and growth potential, allowing traders to know how volatile an asset might be. It is calculated by multiplying the current market price of a coin by the number of coins in circulation.
• Support & Resistance (SR) – Key price barriers that stop an asset’s price from making overly dramatic moves. The price of an asset tends to do predictable things when approaching certain price levels, allowing traders to time their entry and exit into the market.
• Trend lines – a line which can be drawn in various ways to look past the market’s volatility and identify underlying trends in an asset’s price.
• Average directional index: A technical analysis indicator that helps determine the strength of a particular trend.
• Bollinger bands (BB): The BB indicator shows how prices are dispersed around an average value through the use of three separate bands on a chart. They tell us whether the market has high or low volatility, as well as overbought or oversold conditions.
• Relative strength index (RSI): A useful number between 0-100 that indicates when an asset’s price is too far from its ‘true’ value, allowing you to take advantage of an asset being ‘overbought’ (ready for a fall) or ‘oversold’ (ready for a pump).
• Moving average: A tool that smooths out price data by creating a single, flat line that is the constantly updated average price. The average price can be taken over different time periods and shows the overall trend of an asset while eliminating random price fluctuations.
• Standard deviation: A concept applied to an investment’s annual rate of return; provides insight into that investment’s historical volatility.
• Trading volume: A useful metric which helps us understand the strength & conviction behind a price move.

Technical analysis for beginners

If you’re new to trading and TA, these tips will get you started on the right foot.

Don’t bet the house – If you’re new to using technical analysis, you WILL make some mistakes. It’s all part of the learning process. The key is to start small and only trade with an amount of money you are willing to part with.

The best way to learn is to trade – At some point reading & studying can only get you so far – the best way to learn is to get your hands dirty. Just be sure to take the advice from the previous point!  With Digital Surge you can get started trading crypto with as little as $10.

Don’t ignore the fundamentals – Technical analysis is great for short-term trading, but it is not an exact science and it is wise not to ignore elements of fundamental analysis either. Incorporating both FA and TA is the ultimate way to long-term success.

Broaden your analysis – The most reliable price predictions and support and resistance levels tend to be the ones that are confirmed by multiple strategies and technical indicators. Learn as much as you can and always be on the lookout for more TA tools & understanding to add to your arsenal.

Key Takeaways

• Technical analysis (TA) uses statistical trends collected from historical price data to identify opportunities for short-term trades
• Technical analysis has been widely used in traditional investing and the approach in crypto remains the same
• TA believes that history repeats & that traders often react the same way when presented with similar situations
• Fundamental analysis looks at dozens of external factors which help determine an asset’s true, long-term value
• TA focuses on the charts & its numerical data, concerning itself with ‘WHAT’ happens to an asset’s price, rather than ‘WHY’ it happens

What are technical indicators?

Technical indicators are basically tools based on mathematical computations of historical price and volume that assist in predicting future price movements. Thus, these indicators, when used correctly, can show us when an asset is ‘oversold’ or ‘overbought’.

What does ‘oversold’ and ‘overbought’ mean in crypto?

Oversold:

Oversold refers to a situation where an asset is trading way below its true ‘intrinsic’ value. A lot of people are selling this asset, often due to panic selling or market overreaction, and these oversold conditions represents a good time to buy as the asset is underpriced and is likely to go up in the near future.

Overbought:

Overbought is when an asset is trading way above its intrinsic (true) value, without being supported by fundamental reasons. For example, a crypto’s price could be rising and rising despite the project not gaining any actual traction in the real world, these spikes in price are often due to unfounded hype or FOMO (fear of missing out). Overbought is when an asset is overpriced, meaning it is a good time to take profits and sell as a correction is likely to ensue.

What is the Simple Moving Average?

The Moving Average is a technical analysis tool that smooths out price data by creating a single, flat line that is the constantly updated average price. The average price can be taken over different time periods (10 days, 10 minutes or 10 months) and is meant to show the overall trend of an asset while eliminating random price fluctuations.

Moving averages can be useful in determining what an asset has been doing over a set period of time. If the line of the moving average is angled up, you know there is an overall upwards trend and vice versa. If the line is more or less flat, this indicates that an asset’s price isn’t trending in any particular direction and is remaining fairly constant.

EXAMPLE

Let’s imagine we are looking at the Cardano (ADA) chart, which has been seeing some volatility throughout the week.

Saturday: -8%, Sunday: -11%, Monday: +5%, Tuesday: -10%, Wednesday: +20%

Just by looking at the price action from the last five days, it is hard to say what the overall trend was for the week. So if we were looking at the five day moving average, we would calculate: (8+-11+5+-10+20)/5. This would give a result of -0.8, allowing you to see the Cardano’s trend for the last week was actually slightly downwards.

While this is a basic example of how to use the simple moving average, you don’t have to do these calculations yourself as a good trading view chart will do it for you. Common time periods for moving averages are 7-day, 20-day, 100-day, and 200-day.

What is the Exponential Moving Average?

The EMA is similar to the simple moving average, however, the equation is more complex because an EMA assigns more weight and value to the most recent price inputs.

Although both averages have their own utility, the EMA is more responsive to sudden price fluctuations and reversals as more weight and importance is allocated to the most recent closing prices. 

How to use trading volume in technical analysis?

Trading volume is essentially how many traders are participating in the buying and selling. Significant price moves and trends with real conviction are accompanied by a high trading volume (lots of traders are making the same decision to buy/sell), while weak and unsubstantiated trends have a comparably low trading volume.

• It is also important to see that volume is rising over time.
• If the volume is decreasing during increases, the upward trend is likely to come to an end, and vice versa during a down trend.

EXAMPLE

Let’s imagine Ethereum’s price has been on a steady downtrend for the past few months, then one day it spikes from say $2500 to $3000. Now let’s take a look at the trading volume – if the volume is high this could be an indicator that the downtrend is reversing and things are about to pick up for Ethereum. However, if this big price spike is accompanied by a low trading volume, this is more likely to be a temporary rise rather than a complete trend reversal.

Seeing low trading volume behind a significant price movement may indicate a ‘bull trap’, where a low volume/small number of traders buy in large amounts in order to artificially push the price up in order to make people think this is the start of something big. Naïve traders who did not analyse the trading volume may just jump in and start buying, only for those original buyers to pull out, take their profits and send the price crashing back down.

What is the RSI (Relative strength index)?

The RSI is a useful number between 0-100 that indicates when an  asset’s price is far from its ‘true’ value, allowing you to take advantage of an asset being ‘overbought’ (ready for a fall) or ‘oversold’ (ready for a pump). It is essentially a tool that measures the momentum of an asset’s price, but it can also be used to predict trend reversals or to identify support and resistance levels.

• The RSI evaluates an asset price on a scale of 0 to 100, considering a variety of time periods and factors.
• By factoring in the RSI you get a relatively clear sign to get in or out right before the market corrects itself and reverses.
• An RSI score of 30 or less suggests that the asset is probably close to its bottom (oversold).
• An RSI score above 70 indicates that the asset price is potentially near its top (overbought) for that period.

What is Standard Deviation?

Standard deviation is a way to calculate volatility of an asset and is generally used to compliment other technical tools. A cryptocurrency with little price movement has a low standard deviation, and a coin whose prices have moved a lot has larger standard deviation. 

What are Bollinger Bands (BB)?

Bollinger Bands work as a tool to measure price oscillations, indicating to us whether the market has high or low volatility, as well as overbought or oversold conditions. The BB indicator shows how prices are dispersed around an average value through the use of three separate bands on a chart.

The two outer bands react to the market price action:

• Expanding when the volatility is high (moving away from the middle band)
• And contracting when volatility is low (moving towards the middle band)

Generally, Bollinger Bands set the middle line/band as the 20-day moving average, with the upper and lower bands being placed 2 standard deviations away from the middle band.

EXAMPLE

Let’s say Bitcoin’s price is seeing some volatility and one day it begins to spike and move above the moving average and then surpassing the upper Bollinger Band. Generally, the price will touch and rebound one of the upper/lower bands (indicating a support/resistance level) but if the price broke through the upper band you could reliably assume that Bitcoin is overbought and ready for a correction. With that information it would probably be wise to take some profits before things come back down between the two outer bands.

Bollinger Bands allow traders to plan their exit and entry points (similar to the RSI and other technical indicators) but also to look back at past price history to see the previous price levels when the market was overbought or oversold. BB should be used in conjunction with a variety of other technical indicators for best results.

What is the Average Directional Index (ADX)?

A technical analysis indicator that helps determine the volatility of the market and the strength of a particular trend. When the market has low volatility, the ADX will be very low (probably below 20). However, when this figure starts to rise it could indicate a rise in trading volume and volatility.

The ADX is often used to anticipate the end of a market that has not seen much volatility (ranging), indicating to traders the beginning of a trend. Generally, a trend has strength when the ADX is above 25, and a trend is weak (or just moving sideways) when the ADX is below 20.

What are support and resistance (SR) levels?

Support & resistance are key price barriers that stop an asset’s price from continuing their trend upwards or downwards. Support acts as a floor for the price & resistance acts as a ceiling.

Support & resistance are a fundamental part of analysing a cryptocurrency (or any asset) in the short term and they go hand in hand with many technical indicators. This is because they refer to important price levels on a chart that indicate an area at which an asset will predictably:

• Fall to a certain price and then bounce back up as there is a sufficient demand from people wanting to buy at that price, thus preventing the price from dropping any lower (support level).
• Rise to a certain price level and be rejected, causing a reversal into a downwards trend as there are enough people willing to sell the asset at that price. This stops the price from going any higher (resistance level).

SR levels are used by crypto swing & day traders to plan ideal entry/exit points and predict how a crypto asset’s price will move in the near future. These levels prevent overly dramatic declines/surges in price and can occasionally cause a short or long term reversal of the initial trend in the other direction.

How can you find support/resistance levels?

Generally, support forms around the previous price lows, while resistance forms around the previous price highs, so the simplest way is to look at an asset’s price chart and analyse the recent highs/lows in a certain time period.

Keep an eye out for levels & areas where the price has touched, retested and seen a trend reversal. The more times a price level acts as a barrier for a price trend, the more key/established the SR level. There are also a variety of other technical indicators that can help you find SR levels (moving averages, trendlines, Relative Strength Index (RSI), etc.) if you want to confirm SR areas with multiple strategies.

What is going ‘long’ or ‘short’ on a trade?

You can ‘long’ an asset by buying a cryptocurrency (or any asset/stock) at a certain price, and then selling it after its price has risen. Conversely, a ‘short’ is a type of trade where you can turn a profit by betting that an asset will decrease in value.

Traders use support and resistance levels to plan entry and exit points for long/short trades. If the price of a crypto breaks the support levels, it is seen as an opportunity to take a short position (as it appears the price will keep going down).

Alternatively, if the price smashes through a previous resistance level, this is a good sign that a long position might be the best bet as the ceiling has been broken and the price has room to grow. 

What are the pros of using technical analysis in crypto?

• Short-term profits:
  

  TA is perfect for traders looking to profit off short-term market movements.

  
  
• Reliable:
  
  Unlike in fundamental analysis, you are looking at raw numerical data. This data is usually accurate and easier to interpret – incorrect translations, distorted retelling and misinterpretation of data and information is common in crypto
• Data in real-time:
  

  The data you receive in TA is in real-time and you can respond instantaneously. News on the crypto market is often delayed so the traders using fundamental analysis can often get important news AFTER those trading directly on the charts have already reacted to it.

  
  
• Same as other financial markets:
  

  Technical analysis works on the same principle as most financial markets. FA needs a more tailored and layered approach when dealing with crypto markets.

  
  
• Customisable:
  

  TA can work with a number of cryptocurrencies and a trader can choose the most convenient technical tools, specific to the asset they are investigating. Personalised systems can be created which a trader can hone and use to succeed.

  
  

What are the cons of technical analysis in crypto?

Like any other investing tool, technical analysis has its limitations and disadvantages. Here are some of the most notable drawbacks to keep in mind when using TA in crypto:

• Not every asset/market will work:
  

  Technical analysis is more reliable and effective in markets that have high volume and liquidity. High-volume markets are less susceptible to price manipulation and abnormal external influences that could create false signals, making TA useless. This can be a problem in the world of crypto as many low-cap assets have very small market caps and not a lot of trading volume – stick to the big dogs (large, mid-caps) if you’re serious about using TA!

• Less efficient in crypto:
  

  Compared to other financial markets, cryptocurrency indicators change fast and experience a lot of volatility based on a number of factors that TA does not take into account. Often veteran traders struggle to make consistent trades when there is such a high volume of information and volatility.

• Different traders, different conclusions:
  

  Two technical analysts can have vastly different predictions for an asset despite looking at the same chart. Given the amount of indicators and analytical tools and charts out there, your forecast will depend on which methods you use and how you interpret the data. TA is not an exact science, and many beginners make the mistake of thinking that their analysis is rock solid.

• Time consuming:
  

  In addition to spending hours watching the market, technical analysis requires far more time to learn and master than just performing a basic fundamental analysis of a coin. In TA you have to trade and make mistakes to learn and this can be costly and time consuming.

• High stress:
  

  TA is a high-risk, high-reward strategy that suits traders with a good risk tolerance and a level-headed personality. Day trading and trying to turn a profit off short term swings is a stressful game and many new investors opt to buy and hold to avoid this. If you can handle the stress, TA is for you.

• Overly technical:
  

  As you are looking primarily at technical indicators, analysing WHAT is happening rather than WHY it is happening, you could miss great opportunities to buy or sell a crypto when the market is bubbling with fear or exuberance, and fundamental indicators are screaming at your to do so. Combining both TA and fundamental analysis gives you the best chance of success.

• Too theoretical:
  

  Beginners are often taught that certain trading situations and indicators will alert you on exactly when to make a trade. However, situations do not always play out like they do in textbooks, and similar figures in different cases can be very different visually, which makes it hard for new traders to consistently identify the trading opportunities they are looking for.

Handy tips for using technical analysis in crypto

Remember this: Technical Analysis are the tools, but their value is determined by their user. 

TA is not an exact science

Many beginners come into the world of trading thinking that mastering TA will guarantee them success. While TA is undoubtedly helpful when trying to profit in the short-term, TA is not a crystal ball that will show you the future.

You only learn by trading

Unfortunately, all the reading and studying you can do can only prepare you so much for the real thing. Most traders learn A LOT in the first few months of trading. Just make sure you start with small amounts as the first few months can be costly for an overzealous trader.

Possess a thirst for knowledge

Technical analysis and the world of trading is a bottomless rabbit hole. The more interested you are in the science of trading itself (and not just the profits) the more likely you are to have long-term success. Constantly learn and read – trading is not a race – it’s a marathon.

Develop your own strategy

TA uses numbers but your approach can vary wildly. Given there are dozens of ways you can interpret historical price data, each trader will eventually settle into their favourite methods. Get to know as many different technical tools and indicators as you can and you will soon find an approach that is reliable for your style of trading.

Start small

It is inevitable. You will make mistakes and learn A LOT when you first start out. Actually getting your hands dirty is the no. 1 way to advance in the world of TA and trading so if you’re new, only trade with amounts you are completely fine with losing.

Where did technical analysis originate?

Technical analysis has existed, albeit in primitive forms, since 17th century Amsterdam and 18th century Japan. The version of TA we used today can be traced back to the work of Charles Dow.

Dow was a financial journalist and founder of The Wall Street Journal. In the late 1800s he began to observe that assets and financial markets seemed to move in patterns and trends that could be isolated. His work on segmenting and examining these trends paved the way for the Dow Theory which has evolved into the technical analysis we use today.

While Dow’s TA began on sheets of paper and with tedious, manual calculations, modern technology has taken Dow’s principles and turned them into a powerful tool for investors and crypto traders alike.

What is a candlestick chart?

The most popular type of graph crypto traders use for technical analysis is a candlestick chart. While it looks pretty complicated at a glance, it’s actually fairly simple to figure out.

The name candlestick comes from the fact that each plot point on the graph appears similar to a candlestick. They are rectangles that are either red (or pink) or green and have a line coming out of the top or bottom, like the wick of a candle. The size of the candlestick and its line, as well as the color, tells you crucial information.

The top and bottom of the candlestick’s main rectangle are at the opening and closing prices of the cryptocurrency for that day. Green candlesticks indicate that the crypto rose in value so the opening price is at the bottom and the closing price is at the top. Green is positive as the coin increased in value. Red (or pink) candlesticks indicate that the crypto fell in price, so the opening price is at the top and the closing price is at the bottom.

The wicks can come out of the candle on either end of the candle. These show the lowest and highest prices that the cryptocurrency reached within the same period. In other words, the wicks give you an idea of how volatile the market currently is.

Gaining Basic Information From Candlestick Charts

At the most basic level, you can use candlestick charts to see how well the cryptocurrency in question did to make predictions for the future. If, for example, the wicks are long, this indicates a highly volatile market. That, in turn, means that the cryptocurrencies have a higher chance of having given you significant losses or gains in the relevant period. Furthermore, high volatility means the market may correct this tomorrow.

When the candlestick’s wick is short, however, this indicates a potential change to the market. When the top wick is short, it is likely that the highest price of the crypto that day was significant for the coin’s history. In the case of a longer wick at the top, it indicates the coin was significantly more expensive at some point in the day before traders sold it for profit. That type of pattern can indicate an upcoming bearish market that will go down.

Noting a short wick on the bottom indicates people continue to sell the coin. As this would increase the supply, the cryptocurrency’s price will likely drop more. A longer wick, by contrast, indicates the price previously dipped and people think it will not get lower. In other words, traders want to buy the crypto at its lowest value and believe it is there now. That can translate into future upward movements.

Understanding trend lines

Trend lines are a fundamental part of technical analysis, indicating the overall direction that a cryptocurrency’s price is moving (up, down or sideways) by shutting out the noise of the short-term volatility.

Most software for trading crypto will include integrated trend lines, however, many traders choose to draw their own trend lines for increased accuracy (the more accurate a trend line the better your predictions will be). Generally, traders draw trend lines by joining the first candlestick’s lowest price to the next candlestick’s lowest point. From there you can generally extend the trend line automatically.

What other information should you combine with technical analysis?

Ideally, you should never rely solely on technical analysis when trading cryptocurrencies. It is best not to use any single analysis method alone as this will give you limited information. If you were to rely just on technical analysis, you would not get any insight into sentient or news, which are part of fundamental analysis. This is particularly problematic with cryptocurrency trading since factors like mining hash and regulations can have a significant impact on the coin’s price, but technical analysis does not account for them.

How to choose the right time frame when doing TA

When looking at a chart you will be able to choose your time frame for the chart. Some common options include 15 minutes, hourly, four hours, and daily charts, although there are many others.

If you are day trading you should have your time frame set on a short period (five minutes, 15 minutes, and an hour) but if you are looking at longer-term price movements you may want to scroll all the way out to see weeks, months or even years.