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Crypto Technical Analysis: Technical indicators and their uses

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Swen Keller
In the crypto world Swen has consistently found success through his effective communication skills and the unique ability to navigate the details.
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Technical analysis is a method of forecasting future price movements of any particular asset by studying its historical price actions and volume data. Simply put, through technical analysis, traders try to predict future prices by looking at past price moves. 

Technical analysis can be particularly relevant and necessary for investors in the cryptocurrency space, as it is a new and highly volatile market. Technical analysis enables traders to recognize trends and patterns in the price chart, allowing them to make smarter and more informed trading decisions. 

This article will provide you with a comprehensive overview of crypto technical analysis, its origin, and the best crypto technical indicators out there. 

What is Technical Analysis?

The purpose of technical analysis is to give investors and traders enough insights about the current market that is necessary to make thoughtful decisions instead of relying on one’s emotions and gut feelings. Technical analysis involves using a variety of different tools and techniques, including candlestick charts, technical indicators, and chart patterns. 

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    Even though technical analysis has been used in traditional financial markets for centuries, it was only recently that it was introduced in the cryptocurrency space. During the early days of crypto, there was not enough historical price data. Since technical analysis relies on price data, it was less applicable to this newly emerging sector than it has been to other markets. However, over the years, the crypto market has matured and been regulated in some regions, making it comparatively more stable. Moreover, having evolved for over a decade, the crypto market has significant historical price data to implement the technical analysis. 

    Nonetheless, cryptocurrency is still a highly volatile and unpredictable asset market. Investing in crypto assets without a proper strategy and necessary knowledge about the market and the various projects is equivalent to setting on a treasure hunt without a map. It is through technical analysis that traders identify trends and patterns in the market. It allows them to stay ahead of the curve and identify trading opportunities, maximizing their profits and mitigating the risk. 

    Dow Theory

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    The origin of technical analysis takes us back to the late 1800s. It was developed by Charles Dow – an American journalist and financial analyst. He also founded The Wall Street Journal and worked as its first-ever editor for several years. Dow is known as the father of technical analysis for presenting his theory through a series of editorials. Dow theory is a set of principles that can be used to analyze security markets. 

    In 1896, Dow created the Dow Jones Industrial Average (DJIA), which included 12 corporations at the time. Ten of these were rail stocks, while the other two were non-rail stocks. Dow would track the closing price of all these stocks and calculate their average. Later on, Dow replaced the two non-rail stocks with rail stocks and formed the Dow Jones Railroad Average (DJRA). In the 1970s, all the rail stocks were replaced by airline and trucking stocks, and the index was renamed the Dow Jones Transportation Average (DJTA). 

    Principles of Dow Theory

    The Dow theory is based on six fundamental principles.

    1. Market Reflects Everything

    The first and probably the most important tenet of the Dow theory states that all the necessary information about a certain market or security is reflected in its price. And accordingly, the same information reflects the price of the security. For example, if a particular company is consistent in positive industrial output and continues to outperform analysts’ assessments, its stock will attract a lot of attention, moving its price upwards. Conversely, the price will decrease if the industrial outputs are lower than expected and the company fails to reach its projected goals. 

    2. Three Kinds of Trends

    According to the Dow theory, security markets undergo three different kinds of trends, i.e., primary, secondary, and tertiary trends. Primary trends last anywhere from several months to years and are the major market movements. These trends are either bull markets or bear markets, where the prices move upward or downward for an extended period of time. 

    The secondary trends are those that move against the primary ones. These are comparatively short-lived and last from a few days to weeks. The recurring corrections in the primary bull runs and the upward rallies during the bear markets are both categorized as secondary trends. 

    The third kind is tertiary trends. These trends are temporary swings and barely last a few days. They are often regarded as noise in the market, and experts recommend ignoring these trends, as they don’t impact the market in the long term. 

    3. Three Phases of Primary Trends

    The Dow theory suggests that every trend can be divided into three phases. Recognizing these phases gives traders the opportunity to capitalize on the market volatility. The first phase is called the accumulation phase for the bullish primary trend and the distribution phase for the bearish primary trend. This phase occurs when the market sentiment is predominantly opposite of the current primary trend, i.e., positive in the bear trend and negative in the bullish trend. Traders smartly benefit from these phases either by accumulating ahead of a bull market or by distributing ahead of a bear run.

    The second phase, called the public participation phase, is marked by the broader market realization of a new primary trend. During this phase, the prices continue to move in the direction of the primary trend. Market participants start buying more assets, pushing the prices up, or selling their holdings to cut their losses, which moves the market down. 

    The third and final phase is the phase when the overall market speculates about the end of the primary trend. The phase is called the excess phase in case of the bullish trend and the panic phase during the bearish primary phase. 

    4. Indices Must Confirm Each Other

    The fourth principle deals with the start of a new primary trend. According to Charles Dow, a new trend starts only when it is indicated by all the indices. In other words, a trader should not act upon any signal about the start of a new primary trend from any one index unless the other indices correlate with it. If one index shows a primary bullish trend while another is signaling a primary bearish trend, it means the market trend is yet to begin. It is important to note that the only two indices at Dow’s time were DJIA and DJTA. Both these indices were heavily linked and, as a result, naturally behaved in a similar manner.

    5. Volume Confirms Trend

    The fifth tenet states that the trading volume of the market and the primary trend share a direct relation. If the prices start to move in the direction of the primary trend, the trading volume must increase with it. Trading volume is a secondary indicator and measures the amount of trading a certain asset has undergone during a particular period. If the market experiences an upward price action, but the volume is low, the trend shouldn’t be considered primary, as it is not strong enough.

    6. Trends are Valid until a Clear Reversal

    The final principle highlights the need for traders to be cautious regarding trend reversals. Oftentimes, market participants mistake a secondary trend or a temporary swing for a primary trend reversal, which can potentially lead them to significant losses. Hence, traders are advised not to make any decision until the trend reversal is confirmed by a definite signal. 

    Candlestick Charts

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    Charts are one of the most essential tools for any crypto technical analyst. They provide a visual representation of the price action of any market over a period, which makes it possible for analysts to identify patterns and trends. One can find several types of crypto charts on different platforms online, including line charts, bar charts, Kagi charts, and more. However, the one most popular among crypto analysts is the candlestick chart

    Originating in Japan in the 1700s for rice merchants, candlestick charts were introduced to the West about a century later by Steven Nison. This chart quickly gained popularity in the West and soon became the most-used chart type by traders and technical analysts. Nowadays, the candlestick chart is available on all online trading and analysis platforms. The main reason for its popularity is the range of information it provides after just a single glance. 

    As the name suggests, a candlestick chart uses candles to represent price action during a particular period of time. The chart uses two different types of candles, i.e., green and red. If the opening price of the candle is higher than its closing price, the candle will be green. Conversely, if the price closes above the opening level, the candle color will be red. A candle itself has three different components, each communicating a different piece of information. 

    1. Body

    The body is the filled area of the candle, and it represents the range between the opening and closing prices. 

    2. Upper Wick

    The upper wick (or shadow) shows the highest price level the asset/security hit during the period. 

    3. Lower Wick

    The lower wick (or shadow) shows the lowest price level the asset/security hit during the period.

    Best Technical Indicators

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    Technical indicators are special tools used within the crypto and stock market technical analysis in order to extract useful insights from historical price data. These indicators are essentially built on some specific mathematical formulas. The output is provided in some graphic presentations, helping analysts gain different perspectives on the market price movement. 

    1. Support and Resistance Levels

    Support and resistance levels are among the key concepts in crypto technical analysis. These levels are significant in order to recognize market trends as well as to identify potential trend reversals. Supports are the price levels where downward market trends are expected to pause or bounce back. In contrast, resistance levels are the zones of high friction for bullish cryptocurrency market trends. Support and resistance levels are formed due to concentrated demand and supply levels on the price chart, respectively. 

    Support and resistance levels can help a crypto technical analyst to realize potential trading opportunities. For example, a trader may buy a crypto token when the price falls close to a strong support level, with the expectation that the price will rebound as more market participants would want to purchase the same token around that level. Contrarily, the trader may sell the token when the price rises to one of the resistance levels, expecting it to fall soon due to high supply. 

    2. Moving Averages

    Moving averages (MAs) are a significantly useful tool that helps in smoothing out past price data, hence making it easier to identify market trends. Furthermore, it also draws a clearer picture of momentum, support and resistance levels, and potential trend reversals. Moving averages are basically calculated averages of the closing price of a cryptocurrency token over specified periods. For instance, in order to calculate a 10-day moving average, simply track the average closing price of the past ten days. There are two main kinds of moving averages: simple moving averages (SMA) and exponential moving averages (EMA). A simple moving average mainly focuses on the average of past price data, whereas exponential moving averages give more importance to recent prices. 

    3. Moving Average Convergence Divergence (MACD)

    The Moving Average Convergence Divergence (MACD) is a momentum indicator that follows trends by showing the relationship between two moving averages of any one coin’s market price. The first one, the MACD line, is calculated by the difference between 26-day EMA and 16-day EMA. The second line, the signal line, which is shown on top of the MACD line, is a 9-day exponential moving average. The difference between the two lines is indicated through a histogram in the middle. When the MACD line crosses above the signal line, a bullish market trend is expected, and the current price at that time is considered to be a good entry point. However, when it crosses below the signal line, a bullish price trend is considered imminent. 

    4. Bollinger Bands

    Developed in the 1980s by John Bollinger, Bollinger Bands are another important indicator often used in crypto technical analysis. It is used to calculate market volatility and identify potential trend reversals. The indicator contains three bands: the middle, upper, and lower band. The middle band is an SMA, while the outer two bands are calculated by adding and subtracting two standard deviations from the former one. Bollinger Bands can be used in multiple ways in order to find price movement trends, overbought and oversold conditions, and potential breakouts. For instance, when the outer bands are contracting around the price, it signifies indecisiveness in the market, suggesting a possible breakout. 

    5. Relative Strength Index

    Relative Strength Index (RSI) is one of the most powerful technical indicators used in the cryptocurrency market. It was introduced by J. Welles Wilder in the 1970s with the goal of calculating the magnitude of price changes. It is also helpful in recognizing overbought and oversold territories of price on crypto charts. The indicator is displayed as a line graph that ranges from 0 to 100. When the oscillator breaches the 70 mark, the asset is considered to be overbought. And when the value falls below 30, the asset is considered to be oversold. RSI divergences are also considered to be strong signals of trend reversals.

    6. Stochastic Oscillator

    The stochastic oscillator is another technical indicator used to measure the momentum of a crypto token’s price by comparing the closing price to the price range during a certain period of time. The indicator displays two lines, i.e., %K line and %D line, the former being the faster-moving line, and the latter being the slower-moving line. The indicator can be used to identify trend reversals by keeping an eye on the lines when they move to oversold or overbought regions. However, it is important to remember that stochastic lines can stay in these regions for extended periods. 

    Things to Remember

    Technical analysis is the most popular crypto trading and investing strategy that helps in making more insightful buying and selling decisions. However, it is crucial to remember that, like any tool, it comes with its own sets of limitations and considerations. Understanding these can give traders more confidence in navigating the highly uncertain and volatile cryptocurrency market. 

    The most significant limitation of technical analysis in the case of crypto assets is its reliance on historical data. Though it may not be as big of a problem in traditional financial markets, crypto is a relatively newer sector. Often, the industry experiences a number of significant events and sudden market sentiment shifts within a single month. News about government regulations or technological breakthroughs can dramatically impact the market. These factors are not considered while conducting technical analysis, and as a result, sometimes, this approach completely fails to forecast potential price movements. 

    Additionally, human emotions, like fear, excitement, and greed, can play a considerable role in driving the market in a certain direction. Their impact on the cryptocurrency market is far more notable than other financial sectors. Technical analysts don’t account for these human sentiments. 

    Considering these limitations, experts recommend traders not to rely solely on technical analysis in their decision-making. Instead, it is advised to use this strategy in conjunction with other trading approaches, such as fundamental and on-chain analyses. 

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    Conclusion

    Overall, technical analysis is a valuable tool for crypto traders, as it helps them to make more insightful decisions instead of depending on their intuition. Technical analysis teaches crypto traders to recognize market trends, foresee trend reversals, identify chart patterns, and figure out optimal entry and exit points for their investments. Despite its few limitations, technical analysis clears away much of the confusion in the uncertain cryptocurrency market. It allows market participants to maximize their profit potential as well as mitigate the risk factors. Technical analysis is as relevant for new crypto traders as it is for advanced players. 

    FAQ

    Most frequent questions and answers

    No single technical indicator is perfect and capable enough to give flawless predictions. Technical analysts often use a combination of different indicators to get as many necessary insights about the price as possible. However, some of the most common technical indicators are RSI, MACD, Bollinger Bands, moving averages, etc. 

    Both approaches provide their unique benefits and drawbacks. While technical analysis is useful in determining when to enter or exit trade quickly, fundamental analysis assists in assessing the long-term potential of the crypto project. Rather than relying on one of the two approaches, it is better to utilize it simultaneously. 

    Fundamental analysis is often preferred when evaluating the value of a crypto project in the long term. However, ground-level knowledge of technical analysis comes in handy when identifying primary trend reversals.

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    Skrumble.com provides all its content for informational purposes only, and this should not be taken as financial advice to buy, trade, or sell any investment instruments or products, including but not limited to cryptocurrencies, or use any specific exchange. Please do not use this website as investment advice, financial advice, or legal advice, and each individual’s needs may vary from that of the author. Investing in financial instruments, including cryptocurrencies, carries a high risk and is not suitable for all investors. It is possible to lose the entire initial investment, so do not invest what you cannot afford to lose. We strongly advise conducting your own research before making any investment decisions. This post includes affiliate links with our partners who may compensate us.

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