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The basics of technical analysis for the cryptocurrency market

10.11.2021 |

For the article about technical analysis

РA number of traders believe that the cryptocurrency market is still young and influenced by public opinion, which makes it poorly amenable to technical analysis. However, others are sure that this type of situation analysis remains relevant for exchanges, despite its assumptions and peculiarities. The latter is largely due to the increasing liquidity, which remains relatively low to this date.Proponents of technical analysis believe that the cryptocurrency market creates situations where it is precisely this approach that makes it possible to most accurately predict further price behavior. High volatility and a large flow of news content make it possible to highlight local lows and highs on the charts, which can accurately indicate market undertone. Although even a small event can dramatically change the latter in a matter of minutes, especially judging by past experience.

Nevertheless, the current trading on the cryptocurrency market depends more on news, which means it’s more emotionally charged, and it’s not always possible to keep a level head in making informed decisions. Therefore, a technical analysis to forecast future financial price can provide some advantages due to the lack of a human factor.

Technical analysis strategies

Although there are a lot of approaches and strategies for conducting technical analysis on the cryptocurrency market, they can still be classified quite accurately:

  • support and resistance,
  • indicators,
  • technical analysis patterns over long periods,
  • candlestick analysis over short periods,
  • volume analysis.

Experienced traders use multiple strategies of technical analysis, although they all have a slightly different nature. Therefore, it becomes possible to obtain not only a more accurate confirmation of your assumptions, but also quite reliably determine the moments of entering any long-term or short-term trade.

Support and resistance

Support and resistance chart

Support and resistance levels are clearly visible on the chart. Constant volatility creates local highs and lows at each time interval, and you can get a corridor by drawing a line along them, which usually points to a certain direction. The line can be horizontal, ascending or descending. The boundary of the virtual corridor is usually called the support and resistance level, because upon reaching it the price bounces off. Sometimes breakouts can occur, if the price moves beyond the boundary, which indicates the potential for the price to start trending in the breakout direction. A failed breakout is when the price moves through a support resistance level, but then fails to continue moving in that direction and instead reverses course.The more buying and selling that has occurred, the stronger the support or resistance level is likely to be. For example, you can observe on the chart above the price bouncing in the opposite direction each time it reaches the upper line of the blue corridor, breaking through the resistance level for a short time. Therefore, we can say that traders are ready to sell their bitcoins at the upper line, and a small breakdown only indicates a short-term excess of demand.

We can clearly see on the chart an uptrend, when buyers prevail over sellers, as well as sideways market, or sideways drift throughout almost the entire chart with minor deviations. Only at the beginning and at the end did the traders’ sentiments switch to selling, which led to significant declines. Regardless of the direction of the market movement, support and resistance levels can always be observed and usually they are influenced by human emotion, for example, prices may have a difficult time moving beyond a round number.

Common crypto chart patterns

The common chart patterns are most reliable. In those calm moments without breaking news, they allow you to accurately identify entry and exit points. In addition, the common patterns are quite easy to create and to determine the regularity of the price movement.

Chart patterns are usually defined as a series of price actions occur during a trading period, which repeat themselves over and over again. If you can learn to recognize these patterns early they will help you to gain a real competitive advantage in the markets.

Head and shoulders

Head and shoulders on the chart

The head and shoulders chart pattern is used as a predictor for the reversal of an uptrend, including the cryptocurrency market. Typically, such a pattern can be seen after an uptrend or downtrend, which is clearly demonstrated in the chart above. A quite distinct head and shoulders formed by the summer 2020 after Bitcoin’s growth since the end of 2019, after which the price began to actively adjust.In general, if we describe this pattern of technical analysis, then it is formed by three clear peaks, with a center bump that is higher than the rest. The inverse head and shoulders is inverted with the head and shoulders top used to predict reversals in downtrends. For a more complete understanding of technical analysis using the Head and Shoulders pattern, let’s consider the principle of the signal.

1. Identify a trend. It’s easy to see on the chart above, several upwards candles in a row indicate a clear uptrend, but this is not always evidenced. To get an accurate signal, you need to wait for the strongest possible trend.

2. Left shoulder. The left shoulder is marked by price declines followed by a bottom, followed by a subsequent increase. The peak is usually stays below the inclining trendline, so the trend is not broken.

3. Head. The rise in prices is short-lived and the prices start to drop. Prices can often reach trending highs at this point. A breakdown of the upper line of the left shoulder is considered to be a sign of a head, but often a pullback can also break through the lower trend line. All this indicates an imminent trend reversal, but for a more reliable confirmation it is necessary to wait for the pattern to complete.

4. Right shoulder. It’s an indication that buyers are tiring and that the market may be gearing up for a reversal. Some of them still continue to believe in the trend upwards, but it is not enough to establish new highs. At this moment, the right side of the technical pattern begins to form. Ideally, they should be symmetrical, although asymmetrical shoulders are also widely accepted.

5. Neckline. The so-called connects the low after the left shoulder with the low created after the head. The neckline may not be perfectly horizontal; it may be ascending or descending, it depends on the ratio of the forces of buyers and sellers, but it usually does not have a great influence on the further formation of the trend. A break of the neckline activates the pattern and makes the entire setup tradeable.

6. Profit taking. A suitable profit target can be ascertained by measuring the distance between the top of the head and the neckline and using that same distance to project how far price may move in the direction. But it can’t be called accurate. It is worth resorting to other indicators to clarify price limits, for example, the already mentioned support and resistance approach.

Double bottom

Double bottom on the chart

Double top and double bottom, depending on the direction of the trend, are not as reliable as head and shoulders, but together with a couple of other indicators can provide reliable information about the trend reversal. In the classical sense, the double bottom pattern consists of two bottoms that form at a key support level, but in the cryptocurrency market, during technical analysis, this indicator has insignificant deviations, a couple of percent of the price do not matter much.

The formation of a double bottom before the bullish reversal is clearly visible on the chart above. However, in this case, the peak of the second bottom wasn’t reached, which means that it’s quite difficult to get a sell signal with a double bottom only. Therefore, it’s better using other indicators in this case.

Rectangle

Rectangle on the chart

On the chart above, the formation of the Rectangle technical analysis pattern is clearly visible over several time periods at once. It’s very noticeable, especially if its duration is more than one day, as in the example above. The rectangle is formed with support and resistance levels that are drawn with horizontal or flat trend lines, when there’s usually equal number of buy and sell orders. Situations may arise that during a shift to one of the sides, the trend will remain in sideways movement for fundamental reasons, but this has nothing to do with technical analysis, but it’s still worth knowing about these situations, it may come in handy in the future.

The rectangle can be of any height, but the top and bottom lines should be parallel or nearly. In general, trading in a rectangle is similar to support and resistance lines, which make up its borders, but most often the rectangle is used during a pause in a trend for reversal trading, when a deal is made at one of the lines, and closes at the other, after which the position is reversed.

Flag and pennant

Flag and pennant on the chart

The Flag and pennant pattern is typical of a rapidly developing market. This pattern is formed when there is a sharp price movement followed by a sideways price movement and then completed when another sharp price movement heads in the same direction as the move that initiated the trend, like raising a pennant. During the formation of the flag pattern, the market consolidates and liquidity accumulates, for example, during rising trends, some traders can take profit at a certain psychological interval, which leads to an easy correction.During the Flag and pennant pattern and immediately after the sideways trend, the movement continues in the approximately same direction as the prior trend. We can see it clearly on the chart - the movements are roughly equivalent before the flag and after the candle.

Some traders can use more complex patterns, but this requires experience and sufficient understanding of the market - not all of them give quite accurate signals on cryptocurrencies, in contrast to the above. For example, using the support and resistance lines, as well as the flag and pennant pattern, you can handle well without news for fundamental trading.

Japanese candlestick

Japanese candlesticks are one of the most common methods of displaying stock information. The concept of candlestick charting was developed by Munehisa Homma, a Japanese rice trader, back in the XVII century. The usual display of a chart in the form of a straight line is not always convenient for analysis, especially technical. The candlestick pattern divides the time into equal intervals, each of which is displayed in one of the selected colors. A green candle represents a higher closing price than the prior candle’s close, otherwise it’s red. This makes the visual experience more convenient for a trader.

There’s a small vertical line placed at the top or bottom of each candle. This line is known as the wick or shadow, and it represents the given day’s high or low. And the similarity with the flame of a candle gave the name to this pattern. Some technical analysts believe a tall or long shadow means the stock will turn or reverse. Some believe a short or lower shadow means a price rise is coming. In other words, a tall lower shadow means a downturn is coming, while a tall upper shadow means a rise is coming. This isn’t the most reliable indicator, but in conjunction with others, it can be applied.

With some skill, which doesn’t require much time to get, even a novice trader will be able to competently conduct a technical analysis of the cryptocurrency market on a candlestick chart. The simplest patterns are also most applicable for digital assets.

Three white soldiers

This pattern takes its name from a time when charts were drawn by hand on paper and black-and-white monitors. Up candles were white and down candles were black. But now that we use software for our charts, up candles are generally green and down candles are red. So it would be more accurate to call it Three green soldiers.

This pattern involves three candlesticks in a row. If all of them are green, and the opening price of each subsequent candle is higher, then this may be regarded as a stable uptrend. If the last candlestick is shorter than the previous ones — this may indicate an incipient retracement. However, this can also be observed during breaks in trading sessions between different parts of the world. For example, when Chinese traders are resting, active trading has not yet begun in the United States, which leads to a certain decline in activity.

The opposite is also true. When three consecutive candles are black, we can talk about strong bearish moods.

Three white soldiers on the chart

A good example is in the chart above. The classic Three white soldiers pattern is marked in yellow, followed by a further rise. Three more candlesticks are shown in blue, which seem to satisfy the requirement, but most likely this rise is associated with some news background, the third soldier is not strong enough to confirm the uptrend. False signals are shown in red, but they are easy to distinguish, the second candlestick is weak enough to speak of reliability in the first case, and in the second case, each subsequent candlestick is lower than the previous one.

Blanket

This pattern is somewhat similar to the Flag and pennant. If after a dynamic candle there are three or four side retracing parts, but without or minimal decline, and they are followed by a rise again, it’s then when it’s worth entering the market. It is better to do this when the price equals the closing price of the very first analyzed price.

As the other patterns, Japanese candlesticks offer many analysis methods, but not all of them will be applicable to the cryptocurrency market, some due to complexity, others due to the peculiarities of price formation and the reaction of traders to various events. But with practice, you can choose a suitable method for yourself that allows you to predict prices on online exchanges quite accurately.

Indicators

Technical indicators are a statistical form of technical analysis where various mathematical formulas are applied to prices and volumes. Like other methods of technical analysis, indicators can predict further price changes with sufficient accuracy. However, it should be understood that the volume of the cryptocurrency market is relatively small, and its volatility is so high that the indicator may not always have time to react to such rapid changes. This is especially evident at times when the trading volume decreases slightly in anticipation of certain events, and then reacts extremely violently to the news feed.

The most commonly used indicator is a moving average. This indicator is calculated on the basis of the mathematical averaging of the price for a certain period of time, and fairly accurately shows the direction of the current trend. In the cryptocurrency market, the moving average works well only during periods of calm, and in moments of information influence it can lag quite far. Usually, if a moving average is sloping upwards, it means the asset is in an uptrend or gaining in price. But, if it’s sloping downwards, then the asset is in a downtrend or losing in price. A moving average crossover occurs when two or more moving averages cross paths, confirming a shift in the market trend. This indicator can be used with the head and shoulders pattern and, for example, with the double top.In general, there are many technical indicators, each trader is free to choose the most suitable one. In addition to the existing ones, there are many new mathematical theories that allow creating new market tools. It is not uncommon for experienced speculators to create their own technical indicators that take into account many factors important in each different case.

Trading volume

Trading volume is the total number of coins of each cryptocurrency that were traded during a given period of time. This is a fairly reliable indicator, and its analysis occurs when price reaches a certain significant level. For example, when the resistance level is reached, the trading volume may increase, which allows you to profitably enter the market in anticipation of a further increase.There is one more general rule - if price is continuing higher in an uptrend, the volume should also increase and vice versa. some features can be distinguished in volume and price movement analysis:

  • If trading volume increases, prices generally move in the same direction,

  • if trading volume decreases with a strong trend, the trend may reverse or severely weakened,

  • also a decrease in volumes can signal an imminent change in the movement direction.

However, due to the nature of the cryptocurrency market, when one trader can change the direction of the trend by throwing out a large volume of coins at once, not giving sufficient time for an in-depth analysis.

Conclusion

Due to the relatively low volume of the cryptocurrency market, the rate can fluctuate within fairly large limits only because of the desire of a small group to purchase or sell a large volume of a particular digital asset. But even under this condition, a number of traders manage to effectively apply the basic principles of technical analysis to accurately predict the further price movement. It will be enough to learn the simplest tools and approaches to start speculative trading in the cryptocurrency market.At the same time, the news trading strategy shows slightly better results in long-term and medium-term trading. However, it is not so easy to find a reliable source of information, and most importantly, to determine exactly how the market will react to it. For this approach, you can subscribe to thematic channels of the big players in crypto who talk about the strategies of their projects. But in order to apply these strategies with the proper efficiency, it is necessary to understand the process yourself.

As already mentioned, due to the relative low capitalization of the cryptocurrency market, even a small trader’s capital can affect prices on a particular exchange in contrast to an ordinary stock market. And if a group of traders with a sufficiently large volume wants to make, for example, a pump and dump, then they can do it quite easily. And the main task of a retail trader in this situation is to notice it and to join the game in time. Technical analysis is the best way to do this.

All this is relevant both for bitcoin and for alternative currencies, where prices can be influenced by certain groups of traders even greater, because the capitalization of a coin is smaller, which means less money is needed to fluctuate the market. Therefore, before buying and selling coins, you must first study the news, and then resort to technical analysis, and if at least two signals indicate a good moment to enter the market, then it is definitely worth doing it. But you should never forget about stop loss orders.