While cryptocurrencies were developed as an alternate means of payment, they have gained huge popularity as a financial instrument in the present times. Cryptocurrencies like Bitcoin and Ether are being traded like stocks on platforms similar to traditional brokerages.
In such a scenario, tools used for analysing stocks and other securities have also come to be used in the crypto world. These days, reading and analysing cryptocurrency technical charts is essential to make the most of your investment.
Whether you simply want to trade cryptocurrencies for fun or invest in them long-term, knowing how to use cryptocurrency technical indicators can be useful. Technical crypto analysis can help you identify trends and market sentiment to make well-informed crypto investment decisions.
If you’re also curious about how to analyse the crypto market, read on to find out more about cryptocurrency technical analysis tools.
What is Technical Crypto Analysis?
Technical analysis means using historical price movement data to identify trends and patterns and use that to predict future price directions. It is a heavily numbers-driven approach as all the tools used are derived from price and volume.
Technical analysis is not a new thing and has been around since the nineteenth century. Charles Dow, the father of technical analysis, founded the Wall Street Journal in 1889 with his partner Edward Davis Jones to educate readers about the stock market. Dow’s observations about the price movements in the stock market formed the basis of the Dow Theory and later technical analysis.
In the twenty-first century, it has come to be used for newer assets like cryptocurrency along with traditional ones like stocks, commodities and indices.
Six Principles of Dow’s Theory
Charles Dow was responsible for creating the first stock market index in 1884. The Dow Jones Industrial Average(DJIA) was created in 1896 and is a price-weighted index that tracks the 30 largest publicly traded companies in the US.
Over time, Dow’s Theory has undergone changes due to the contributions of other analysts and lost emphasis on certain aspects such as the transportation sector. Still, it is important to understand the six principles of this theory to gain a better understanding of crypto technical indicators.
The six principles of Dow’s Theory are:
The Market Reflects Everything
The first principle of Dow’s Theory states that all available information related to an asset is already incorporated in its price. In other words, the market reflects all asset information in its price.
Three Types of Market Trends
There are primarily three kinds of trends in the market. First, primary trends are major market movements that are expected to last for months and years. The bull market where prices of assets show an upward trend and the bear market where asset prices experience a downturn are considered to be primary trends.
Secondary trends are something that exists within the larger primary trends and usually work against the latter. They include pullbacks in bull markets and rallies in bear markets.
Tertiary trends are short-term trends that last for a little over a week and are usually ignored as they don’t affect long-term movements.
Primary Trends have Three Phases
According to Dow’s Theory, primary trends undergo three main phases. The first phase is called the accumulation phase for bull markets and the distribution phase for bull markets. The former generally occurs when market sentiment is still largely negative for a bull market and the latter is when the sentiment is positive in a bear market.
The second phase called the public participation phase signifies the market’s realization that a new primary trend has begun. This phase witnesses rapid price rise and fall as the market either starts buying more assets or selling them off to cut its losses.
The final phase for bull markets is the excess phase and the panic phase for bear markets. During this time, the public continues to speculate while the trend is about to end.
Indices Must Correlate with Each Other
For a new trend to be confirmed, signals from both market indices must correlate with each other. This means that if one index signals a primary upward trend and another confirms a primary downward trend, it should not be assumed to be the beginning of a new market trend.
A new trend is confirmed only when both indices signal the same trend. One thing to note here is that the main indices during Dow’s time were the DJIA and the Dow Jones Transportation Average.
Trends should Correspond with Market Volume
Simply put, this principle states that market volume should increase accordingly in a bull market and decrease in a bear market. Trading volume is generally taken as a secondary indicator where low volume signifies a weak trend and high volume signals a strong trend.
Trends Persist Until a Reversal is Clear
According to the final principle of Dow’s Theory, market trends persist until a definite reversal occurs. Therefore, traders should be cautious during trend reversals as primary trend reversals can easily be confused for a secondary trend.
Cryptocurrency Technical Indicators
Candlestick Charts
Candlestick charts are a great tool to gain better insight into the crypto market. They have a simple structure but can reveal lots of information about the market to the users. On a basic level, candlestick charts show whether the crypto market’s price movement was positive or negative during a given period and the degree of such movement.
The horizontal axis is used to show time and private data is shown on the vertical axis. Now, crypto charts can be set to different timeframes and candlesticks are used in these charts to represent a particular timeframe.
Just like an actual candlestick, the candlestick in a crypto market chart also has a body and a wick. The body signifies the opening and closing prices and the wicks represent the highs and lows of a cryptocurrency in the given time period. The top wick shows how high crypto price went in that particular timeframe while the bottom wick shows how low it went.
Similarly, you will notice that candlesticks are either green or red in color. Green indicates that prices went up during the period in consideration and red indicates the opposite. Candlestick charts, therefore, can reveal a lot of information and can be used by technical analysts to identify potential trend reversals.
For example, a long wick on a candle body can signify that traders are making profits and a sell-off may occur soon.
Support and Resistance Levels
Support and resistance levels indicate the market’s past peaks and troughs. They are identified with the help of trendlines and can make it easier to read candlestick charts.
Support levels refer to price points during pullbacks when cryptocurrency prices halt at a particular level due to the concentration of buying interest. Traders test the support level several times as they feel more comfortable entering long-term trades if the support level does not break after repeated tests.
Resistance levels are price points where demand matches supply. There is a concentration of selling interest as more traders are willing to sell at this price. As with support levels, resistance levels are also tested multiple times to assure traders that they can comfortably short the security.
Moving Averages
A moving average is a technical analysis tool used to identify probable crypto market trends. It generates the average price points for a given cryptocurrency during a particular timeframe. Moving averages can be adjusted to time periods and, hence, can offer valuable insight when dealing with real-time crypto charts.
To create one, you need to divide the number of data points over the chosen period by the total of each data point. Moving averages can be used both for long-term and short-term analysis with their lengths ranging from 10 to 200 days.
As they are lagging indicators, moving averages are used by traders as signals to buy and sell crypto assets.
On-balance volume indicator
Created by Joe Granville, the On-balance volume indicator(OBV) focuses on cryptocurrency trading volumes to measure buying and selling pressures. This is because OBV works under the assumption that trading volume is a major driver of market price movements.
OBV is, therefore, a running total of cumulative volume that rises or falls depending on the trading volume of the days included in a given period. It rises when up days’ volume outnumbers down days’ trading volume and vice versa. OBV is often used to confirm trends along with live crypto charts.
Relative Strength Index
The relative strength index(RSI) is a momentum indicator developed by J. Welles Wilder. It is shown as an oscillator and is used to measure whether an asset, in this case, cryptocurrency, is being overbought or oversold.
RSI ranges from 0 to 100 and usually uses a 14-day timeframe. A cryptocurrency is considered overbought when the oscillator is above 70 and oversold when the index drops below 30.
Moving Average Convergence Divergence
The moving average convergence divergence(MACD) is a popular indicator developed by Gerald Appel in the late 1970s. Like RSI, it is an oscillator that fluctuates above or below a centered line. It is plotted with two lines- the MACD line and the signal line.
The MACD line is the difference between the 12-day exponential moving average(EMA) and the 26-day EMA whereas the signal line is the nine-day EMA of the MACD. These two lines fluctuate around a center line. It is considered to be a bull market when the MACD line goes up and crosses the signal line. On the other hand, a bear market is signified by the MACD line turning down and crossing the signal line.
Bollinger Bands
Bollinger bands are used to identify short-term movements in the price of assets such as cryptocurrencies. A standard deviation is added or subtracted from the 20-day moving average to create the Bollinger bands. These bands are customizable and expand and contract based on crypto prices.
Bollinger bands indicate periods of high and low volatility and generally are not used on their own but in tandem with other indicators for technical analysis. Largely, a cryptocurrency is considered overbought when its price goes above the upper band and oversold when prices move under the lower band.
Does Technical Analysis Work for Cryptocurrency?
Technical analysis is important as it helps to identify trends and patterns in cryptocurrency prices. This is crucial for traders and investors to gain insights into the market behavior of a particular cryptocurrency. Technical analysis, thus, helps crypto traders manage risk while dealing with an extremely volatile asset.
However, technical analysis does not fully work for cryptocurrency as it relies heavily on historical data to predict future price movements. This has limited use in the case of fast-moving crypto assets.
Further, technical analysis is a numbers-driven analysis based largely on price and trading volume data. There are other factors such as regulatory environment and news events that affect crypto prices but are not reflected in a technical analysis. Therefore, it is essential to not rely solely on technical analysis to make investment decisions especially when it comes to cryptocurrency.
Conclusion
Technical analysis is a major strategy used by crypto investors to predict future price movements and manage investment risk. It focuses on an asset’s past market performance to analyze its future prospects. Thus, the various technical analysis tools and charts help crypto traders make well-informed investment decisions.
However, this analysis technique has its limitations and one should not solely rely on it to formulate investment strategies. As cryptocurrencies are particularly volatile, it is always better to develop a strategy in consultation with a financial advisor.