Fundamentals of technical analysis in cryptocurrency trading

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Technical Analysis Methods

Many traders are quite critical of the use of technical analysis for trading cryptocurrencies. Admittedly, there is a reason for this. But other equally experienced traders believe that technical analysis remains an urgent tool for working with such a specific tool. It is applicable to Bitcoin, as well as to any other currency and stock markets. But due to the low liquidity on cryptocurrency exchanges, the use of technical analysis has its own characteristics.

In some situations, technical analysis may be even more useful for Bitcoin than for other assets. Since this market has a very dynamic news flow and high volatility. In addition, a series of the largest highs and lows on the chart underline the mood in the market. As the experience of previous years shows, price changes in the digital currency market can be very powerful. Now we can say that the Bitcoin exchange rate is highly dependent on headlines in leading media and crypto traders often make decisions only depending on positive or negative news. Therefore, the ‘technical’ trader has a chance to react more carefully and independently of other people’s opinions.

The number of methods used by technical analysis is very large. But they are divided into several fairly specific classes:

  • Levels and lines of resistance and support
  • Technical indicators
  • Shapes (patterns) on large areas of the chart
  • Candlestick Analysis – candlestick patterns or short bars
  • Trade statistics – volumes, glasses, etc.

Let’s consider each of them closer. As a rule, experienced traders combine several different techniques in their methods and wait for their mutual confirmation – such a joint signal can be considered more reliable for transactions on the market.

 Lines (levels) of resistance and support

The price is constantly changing, forming a chart, there are peaks and dips on it, which mark the highs and lows. If you draw a line along a sequential series of highs or lows, then it will be called, respectively, the line of resistance or support. These are the values ​​of quotes at which the cryptocurrency rate feels a significant barrier, after which a reversal is possible. The horizontal lines of support and resistance are called levels.

Strong levels of support occur in places where a large number of large purchase orders are concentrated. The same is with the resistance level, which is determined by the presence of a significant list of sell orders. One of the main definitions that traders are faced with is the trend and trend movement of the price. A trend in itself is just a channel made up of parallel resistance / support lines.

The direction of the trend movement is determined by the slope of the lines. If they are directed up, then the trend is called upward. This means that cryptocurrency trading is dominated by purchases. For a downtrend, the opposite is true. A side trend (or flat) is a movement in which resistance / support lines are horizontal and approximate equality of sales and purchases is observed.

The main figures of technical analysis

The most accessible patterns for use are simple figures of technical analysis. They are based on easily determined patterns of movement of cryptocurrency quotes.

A figure is a certain characteristic drawing that describes the change in the price of a crypto-tool, which traders again and again notice on the chart. Based on repeating, similar to each other figures, over time you can learn to make predictions about further movement.

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.

Consider how to work on this graphic model. The recommendations apply to the same extent to the inverted model, with the only difference being that instead of highs, price lows are formed and as a result the signal is sent to buy rather than sell.

1. Trend Definition
First of all, it is necessary to state the development of an upward, bullish trend. A strong uptrend must necessarily precede this graphic model.

2. The left shoulder
Then we wait for the formation of the left “shoulder”, which on the chart looks like a new maximum with subsequent correction. Moreover, the lowest correction point, as a rule, does not fall below the current trend line.

3. ‘Head’
Now, after the completion of the correction, the turn of the “head” comes. It looks like a powerful price impulse in the direction of the current trend. He sets a new maximum, but the price immediately rolls back to the very level where this impulse started from and breaks the current trend line. This casts doubt on the strength of the bull trend.

4. The right shoulder
But the strength of the bulls is still sufficient to try to correct the situation, so they enter the market and push the price up. However, the lack of potential buyers leads to the fact that the price can not set a new maximum and rolls back, forming the right shoulder of the model. Although in theory it is assumed that the right and left “shoulders” will be symmetrical, in practice this does not always happen.

5. Breakthrough of the “neck” line
After the price rolls back, failing to set a new maximum, it approaches the so-called “neck” line, which is drawn along the minimums of the left “shoulder” and “head”. The ‘neck’ may have an upward slope, a horizontal position or a downward slope – depending on the ratio of the strength of the bulls and bears. A classic sell signal appears when the price breaks the “neck” line down.

6. Target profit
It is recommended to exit this trading position after the price overcomes a distance equal to the distance from the maximum of the “head” to the level of the “neck”. But this is only an approximate goal, the refinement of which must be done using other tools, such as support / resistance lines, Fibonacci proportions and moving averages.

Double bottom or double top

A double bottom is one of the most common figures that occur after a downtrend, respectively, a double top after an uptrend. The Double bottom shape is very similar in nature to the Double Top shape. They are identical, with the only difference being that they are, as it were, a reflection of each other.

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

The Rectangle shape is easy to spot on the chart. The rectangle is a kind of pause in the trend, during which buyers and sellers are approximately equal. The distinguishing features of the rectangle are smooth support and resistance lines; Support and resistance are two horizontal sides of an imaginary rectangle. The vertical sides of the rectangle are completely arbitrary.

The rectangle is a simple figure in technical analysis that demonstrates the struggle between sellers and buyers. It is important to remember that a pattern only triggers when the price crosses one of the horizontal sides of the rectangle. While it is not clear which of the players won this ‘rectangular’ fight, it is not necessary to consider the figure completed.

 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 should be preceded by a sharp change in prices. The consolidation pattern itself is limited by support and resistance lines that are parallel or slightly converging, forming a figure similar to a flag, tilted, as a rule, in the direction opposite to the direction of the trend, or located horizontally. After the breakdown, the price movement should at least repeat the distance traveled before the formation of the figure.

More sophisticated systems for working with graphic patterns, such as Elliott waves and the like, can also be used in cryptocurrency trading. But their description will be too long for this article.

 Japanese candles

This type of graphical analysis was invented by the Japanese rice trader Munehisa Homma in the 17th century and is now one of the most common methods for displaying any market data. Watching a regular price chart is not very convenient, therefore, to build a ‘Japanese candlestick’, time is divided into periods. Such a division into periods makes the overall picture clear, which helps to judge the trend and trend changes.

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.

In the form of a vertical line in the body of the candle displays the maximum and minimum price. Thanks to the shadows, similar to the candle wick, the figures got their name. 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 with the bottom) may indicate further growth, and the longer lower part of the fall.

Candlestick Patterns

Japanese candles are universal. They can be used by both experienced professionals and novice traders. Examples of candlestick analysis figures:

Three advancing white soldiers
This model consists of 3 consecutively rising white candles, with the closing price of each subsequent higher than the previous one. This figure confirms the bullish sentiment, so with a high probability we can talk about the beginning or continuation of the upward movement. If after the formation of 2 pronounced white candles against their background, the third one seems small – there is a possibility of the formation of a possible short correction on the market. At this time, long positions should be limited for a while and gradually closed previously opened ones.

Cover
The veil is another model of the continuation of the upward or downward trend. After the formation of a long white candle, a slight lull occurs. At this time, 3-4 correction candles are formed that do not have a downward movement. When a white fast-growing candle appears after them, it is necessary to open a long position at the maximum of the white candle, from which the formation of the model began, the exact same strategy is true for a short position.

Today, there are a huge number of candlestick patterns. They have different names, but for cryptocurrency traders, it is important to learn how to interpret them correctly.

 Indicators

It is customary to call technical indicators in trading a graphically displayed result of mathematical calculations by a certain formula, determined on the basis of past changes in price or other initial market data. The indicator chart is used to predict future price changes.

Most of the simple strategies based on technical analysis are somehow related to the Moving average indicator. It performs mathematical averaging of prices taken over a certain period. As the rate changes, the value rises or falls, which allows you to determine the general tendency of the cryptocurrency instrument to move in the future and make a profit by simple mathematical calculation.

The rules for using the moving average are quite simple: if the price is above the moving average, then the price rises, if lower, then it falls. For a more accurate forecast, you can take two moving averages with different time periods. Where these lines intersect, a change in trend is most likely to be expected.

Despite the apparent simplicity, this type of technical analysis is very popular due to the simplicity and long-term forecasting.

In addition to moving averages, a huge number of technical indicators have been developed and they continue to appear. Indicators – the most popular and well-developed of the methods of technical analysis. For “physicists,” he is good because he is based on mathematics, not vague reasoning, and gives unambiguous answers. Unambiguous, however, for each trader individually. And indicators prone to eternal doubts help the decision-makers not just like that, but “according to science”. Therefore, even if the indicators fail the trader, he rarely looks for something else, and continues to conjure with their settings.

The usefulness of indicators is discussed no less hotly than the usefulness of technical analysis of markets in general. They are used on cryptocurrency exchanges in the same way as on all others – that is, in combinations and with endless searches for ideal parameters.

However, when trading cryptocurrencies, you can use both classic indicators – MA, MACD, RSI, Stochastic, Momentum, ZigZag, etc., as well as more specific ones developed for other markets. Or even create your own indicator, specifically for trading Bitcoin.

But due to the low liquidity and high volatility of the bitcoin market, you need to remember a few simple tips:

  • Bitcoin is characterized by a “freezing” of trading for a long time with a fall in volumes, and then a sharp jerk caused by an important event. Classic indicators do not have time to respond to such jumps.
  • To reduce the effect of volatility, one should avoid using indicators for short periods for intraday trading, it is better not to take periods below H1.
  • Trading volumes show frequent and sharp leaps, sometimes committed by a single trade. If you decide to use indicators based on volume, they need to be very finely tuned based on real statistics.
  • On some exchanges, sometimes unreasonable “candles” appear in the amount of tens of percent, of the major exchanges BTC-e is especially famous for this. On other exchanges at the same time, everything can be calm. Indicators usually do not respond to such antics and, moreover, cannot predict them at all.

 Trading volumes

Trade volume is represented as the total number of units of the traded cryptocurrency, which passed from hand to hand on the basis of executed orders. For analysis, it is very important to measure the volume that arose when the price reached a certain level. This can be a strong signal to start trading in anticipation of further price movement in the right direction.

Various software platforms for cryptocurrency trading use the vertical and horizontal volume representations. The greatest prevalence on exchanges was vertical volume.

Vertical volume

In this case, a list is formed with information about the size of all transactions concluded for a certain period of time and is displayed in the form of columns under the price chart in time relation. The time interval for constructing one column is the same as on the price chart. That is, if an hourly chart is used, then the volume is presented in the form of columns, each of which indicates the total volume of trade for the past hour. For the daily chart, it is calculated for the entire trading day.

The most practical option for using the volume may be to determine the end of the corrective movement in the trend. A strongly increased volume at a price going against the main trend may signal its end. This moment is advantageous to start trading in the direction of the trend.

This type of technical analysis can be seen on the BTC-E exchange page. Like the ‘Japanese candles’, it is also interval. Data is plotted in the form of columns, the height of which corresponds to the volume of trades for the period. Large volumes can “undermine” price fluctuations, while small volumes, on the contrary, can narrow. General patterns can be distinguished:

  • If the volume grows with further price movement in this direction, the market supports this movement.
  • If the volume of transactions decreases with further price movement in this direction, the market does not support this movement.
  • A change in trading volumes may be an early signal for a trend change. In the event of a fall in prices and a decrease in trading volume, one can expect a fall and vice versa.

Summary

As a rule, the courses are managed by groups of players that are scattered by the specificity and purposefulness, capable of increasing trading volumes at one time. Nevertheless, many participants successfully apply a small list of technical analysis elements to predict price movements. In this case, only basic tools and simple approaches that are easier to interpret are used.

News trading strategies are effective, however, it can be difficult to find adequate news on cryptocurrencies and most importantly on time. One of the best sources of news is the thematic forums and blogs in which players often post their thoughts and comments on the further development of events. In the media, news on cryptocurrencies, if they appear, is with a long delay, which negates their relevance.

It should be borne in mind that on the cryptocurrency exchange, the bulk of the movement is created by limited groups of participants who trade in large volumes and are able to make a significant correction to the exchange rate. And given the small capitalization of the main cryptocurrencies so far, even a trader with a relatively small deposit (compared to the stock market) can significantly affect the rate. Such groups or individual players are unlikely to talk in advance about their intentions, it remains only to manage to detect the beginning of events in time and place appropriate orders.

All warnings and notes about volatility that are valid for Bitcoin trading should be “multiplied” several times for altcoins. Even the meager capitalization of Bitcoin compared to the stock exchanges is measured in billions of dollars, while for most forks it is just a few million, and for the less popular, it’s a pitiful tens of thousands. Therefore, an entrepreneurial trader or group, even with a small capital, can perform Pump & Dump operation (rise and fall) for any fork, selling their coins at the peak to those who are hoping to make money on a further takeoff. And he may never happen again.

In any case, before placing an order on the exchange, it is necessary to conduct a thorough technical and fundamental analysis of the situation, and only if there are two or more confirming signals to enter the market.

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