What is technical analysis in trading?

What is technical analysis in trading?

If all you do is place buy and sell orders on crypto assets based on guesswork or a recent hype, that is a pure gamble, and you might get severely burnt. As a trader, you need to gather as much information surrounding the market and which cryptocurrency you intend to trade. Technical analysis is one way to do information-gathering before placing a trade.

What is technical analysis?

Technical analysis means different things to different folks. To a newbie, having adequate knowledge of chart patterns provides the perfect basis for predicting cryptocurrency or stock market prices. Others see technical analysis as a means to hit the jackpot by predicting prices and market movement. However, regardless of what you think about technical analysis from a first glance, let’s break it down together.

Technical analysis involves using data generated from market trends or reversals to predict future market moves. Predictions result from how prices move and the volume of trades on crypto assets to determine demand and supply imbalances. Traders use this strategy to identify buy and sell opportunities, accurately pointing out lows and highs on preferred crypto assets. Technical analysts use tools and indicators to calculate and study order flow, charts, and algorithms behind trend moves.

It might sound somewhat easy to predict prices, but it is a bit more complex. Technical analysis has its background on three basic assumptions because of its dependence on predictions and trends.

The market creates discounts on everything.

It is an assumption that everything that can affect a crypto asset is factored into its price. The price of cryptocurrencies indicates that all conditions like trader’s psychology, government policies, employee layoffs, and developer’s news determine the trend.

Trends determine price action

Opening the trading chart of a crypto asset overwhelms newbies who have a nightmare understanding the greens and reds (candles). To a trader who has put in the time and effort to learn technical analysis price action reflects the trends. In spite of the timeframe a trader uses to analyze the charts, a future price movement can be predicted.

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Historical events tend to repeat

Technical analysis follows from the psychological belief that trends in the cryptocurrency market repeat themselves. Whenever prices reach a certain threshold, traders react in the same fashion as in the past. Therefore, technical analysts hold on to the notion that trends can repeat themselves despite happening a long time ago.

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Fundamental technical analysis concepts

A trader who looks to place trades using technical analysis tools never truly becomes an expert. The market is a teacher, and everyone who trades should dedicate himself to lifelong learning. There are several technical analysis concepts that traders need to know to become knowledgeable. Without understanding these, it is near impossible to become a profitable trader.

Market Trends

The foundation of any profitable trading strategy is trends. When trends occur, there is a sustained movement in demand and supply imbalances in a particular direction: up or down. When the demand for a crypto asset is higher than the demand, prices go over the roof but drop when supply exceeds demand.

Identifying a market trend is pretty simple. Traders in uptrends should seek higher highs and higher-lows and lower highs and lower-lows in downtrends to confirm market momentum. A trader can measure market momentum in trends by seeking to know how fast price move in a particular direction. You will discover which force controls the market momentum at that point: bulls or bears. Whenever the speed decreases, the previously extreme prices of crypto assets no longer hold, and prices move in the opposite direction.

Support and Resistance

The support and resistance concept is one of the first things a new trader gets to learn and is key to identifying buy and sell levels. The market reaches a point where the prices of crypto assets don’t exceed or fall below specific prices. Support is a level of large buy orders where prices find it difficult to go below. Whenever the price nears this level, buyers become aggressive to push up the price from going lower. Resistance is an area of large sell orders that limits crypto assets from going above specific prices. At the point of resistance, sellers begin to sell their holdings aggressively whenever it reaches the resistance price level.

If that explanation is a bit too hard to swallow, here is an illustration that might help you understand. Think of a man standing inside an apartment building with a roof directly above his head, and the floor is composed of impenetrable wood. He tries to jump high to see what is outside the building, but his head constantly meets with the roof. The roof is like a resistance to the man’s head getting above the building. On the other hand, he switches to jumping so hard to break the wood so he can get into the apartment below him, but this proves impossible: the floor is so thick and formidable that he gets exhausted. That there is support.

Overbought and Oversold Assets

In cryptocurrency trading, unlike stock market adherents who believe that there are no bad stocks, but bad prices, crypto traders need to watch out for terrible rug-pull crypto projects. That said, prices of cryptocurrencies can get poor: overbought and oversold. Now, this isn’t something negative as it suggests. As simple as it sounds, an asset is overbought when the price reaches rates beyond its market value with buying pressure from investors. And it is oversold when it goes far below its market value, with investors selling off aggressively.

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These two scenarios could signal the reversal of an uptrend or downtrend. Traders who can tell market movements using indicators and tools of technical analysis can know what steps to take. The next part of this article will focus on that as you will find out tools and indicators of technical analysis.

Technical Analysis Tools and Indicators for Every Trader

Although some technical analysts might argue that some of the concepts mentioned above are indicators of market price movements, we will consider more technical aspects of technical analysis. Technical analysts use these accessible tools to determine where to input stop losses, take profit levels, and guide decision-making at every point.

Relative Strength Index (RSI)

The relative Strength Index (RSI) is an oscillator that identifies the momentum of an asset. It indicates whether a crypto asset is overbought or oversold. Technical analysts use this indicator to measure the changes and speed of an asset’s price movement. The RSI indicator reads from 0 to 100. Crypto assets that fall below 30 indicate oversold, while 70 and above spells an overbought asset. Whenever a crypto asset is overbought, traders tend to sell off their assets and buy aggressively when it becomes oversold.

Bollinger Bands

Bollinger band, named after its founder John Bollinger, a technical analyst trader, are indicators that measure the price and volatility of crypto assets. The Bollinger indicator has three parts: the 20-period simple moving average (SMA) and two bands (upper and lower) standard deviations from the simple moving average.

The upper and lower Bollinger bands represent a positive and negative standard deviation. The upper Bollinger band signals an asset is overbought when the price grows beyond normal and usually occurs when the price is above the Bollinger band. The lower Bollinger band shows an underlying crypto asset as oversold when the market price goes below the Bollinger band. Usually, when the Bollinger bands begin to expand away from the 20-period SMA, the crypto asset becomes volatile and becomes less volatile once it contracts.

Moving Average (MA)

The moving average technical indicators are straightforward tools for technical analysis. They measure the average price of tradable assets over a specific time. The indicators signal an asset is on an uptrend when it moves up in a bullish direction and a downtrend when it moves down in a bearish manner.

The moving average is also understood as a lagging indicator because they give a delayed analysis of price movement after it happens. The most commonly known of this tool are the simple and exponential moving averages. The simple moving average (SMA) collects data on trends whose directions don’t change. The exponential moving average (EMA) captures price changes quickly and is suitable for short-term traders. Traders can check trends using different timeframes for different results. The timeframes that traders use popularly are the 200, 50, and 20-period moving averages.

The 200-period moving average calculates the average price of a crypto asset over the past 200 days. It adds up the average prices and divides the total figure by 200. It is a valuable tool for long-term traders to identify uptrends and downtrends while also providing price support and resistance zones. Once the price of a crypto asset is above the 200-period moving average, it signals a bullish uptrend and a bearish downtrend when it is below the 200-period moving average. The 50-period moving average shows the average price for cryptocurrency that investors willingly paid over the past ten weeks of trading. The average price is known as the support level for the underlying asset.

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When the 50-period SMA crosses the 200-period SMA from up to down, it signals a Death Cross telling of an impending bearish market. On the other hand, when the 50-period SMA crosses the 200-period SMA from down to up, it shows a Golden Cross that signal a bullish market. Finally, the 20-period moving average is preferably for short-term traders because it measures the average price of assets over the past 20 daily candles. Traders use this technical tool to detect buildups leading to a breakout. Although short-term price movements are evident, they can be a bear or bull trap.

Moving Average Convergence-Divergence (MACD)

The MACD shows the relationship between two moving averages of a crypto asset’s price, reflecting the momentum of price trends. Traders calculate MACD by subtracting the 26-period EMA from the 12-period EMA to form the MACD line. The 9-period EMA of the MACD (signal line) plotted over the MACD line identifies dominant buy and sell signals. Traders can sell off a crypto asset when the MACD crosses below the signal line and buy when the MACD crosses above its signal line.

Average Directional Index (ADX)

The ADX technical tool measures the direction of crypto asset trends. It has two volume indicators that measure the strength of cryptocurrency trends. Traders can use the level of present trends to place buy or sell orders. When calculating ADX levels, the periods are usually broadly divided into 14 bars. Analysts can plot the ADX for shorter timeframes using 7 bars or longer ones at 30 bars. The ADX indicator has line values ranging from 0 to 100. Values below 25 represent a large-scale accumulation phase, while 25 to 50 confirm a trend with the prices of crypto assets attempting to reach support or resistance levels before a breakout.

Stochastic Oscillator

The stochastic oscillator is an indicator that calculates the momentum of crypto asset prices. The trend momentum of cryptocurrencies has to change before price changes. The stochastic oscillator is like other technical indicators that measure crypto assets price on a scale from 0 to 100.

Generally, the timeframe is an ideal range of 14-period regardless of whether the goal is 14 days, weeks, or months. Readings on the stochastic oscillator below 20 indicate the price of a crypto asset is near its lowest point in the timeframe. When the stochastic oscillator reading climbs above 80, the price is near its highest price on the chosen timeframe meaning it is overbought.

Final Thoughts

Employing technical analysis to read crypto market price movements can help change your decision-making. While it has some inconsistencies—especially when history doesn’t repeat itself and when not balanced with fundamentals, it remains key to placing the right buy and sell orders. We recommend that you test and combine some of the tools and indicators available to you until you find a consistent strategy to navigate your way in trading cryptocurrencies.

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