Understanding Technical Analysis in Cryptocurrency
What is Technical Analysis (TA), Fundamental Analysis and Why Are They Important in Crypto Investing / Trading
Technical Analysis (TA) describes analyzing historic price and volume trends to predict the future price movements of assets.
This form of analysis is accomplished by applying mathematical calculations called “technical indicators” to the historic and current price and volume data of an asset to detect and analyze trends (to preform “trend analysis“).
Although this data can all be considered algorithmically, it is common for analysts to apply these indicators to charts (thus creating a way to analyze trends visually; to preform “chart analysis“).
Popular technical indicators used by technical analysts include potentially familiar terms like Moving Averages (MA), Elliot Waves (EW), and the Relative Strength Index (RSI).
For example, in the image below, a version of the average price of Bitcoin over 12 and 26 days is plotted on the chart below to offer a visual of the direction of Bitcoin’s price (specifically this chart looks at 12 and 26 day exponential moving averages to give us a sense of how they are converging and diverging).
NOTE: Technical analysis can also analyze other data, for example open interest in futures trading. For simplicity’s sake this page page refers to all trends studied by technical analysts as “price and volume” trends.
The Core Concept Behind Technical Analysis
The core idea here being:
- What has happened in the past can give us an idea of what will happen in the future (it allows us to calculate odds, not see the future of course).
- The next wave of investors will tend to follow the trends of the last wave.
- Human behavior in markets is somewhat predictable.
- Therefore, studying factors like past volume and price trends along side the current volume and price, can tell us about the likelihood of future volume and price trends.
- Since the above is true, it can help to plot everything on a chart to get a quick and simple visual of potential paths the price might follow.
Bottomline: Technical Analysis doesn’t analyze the fundamentals of an asset (although any analyst worth their salt will ALSO do this). Instead, TA is centered around charting and using technical indicators to better predict the likelihood of short-term, medium-term, and long-term trends based on historic and current price and volume data. Here we have to stress that technical analysis isn’t about certainty, it is about finding future likelihoods based on past trends. An good analyst never speaks about what will or must happen, they simply plot out what could happen based on data, and then consider the likelihood that each possible set of events has of occurring.
TIP: For good TA sources see TheChartGuys, TradingView, and to some extent Steemit.com. These are free to use sites that host a lot or are centered around TA. Check them out, specifically TradingView is a vital and free resource for any crypto trader, Steemit can go either way, and ChartGuys is a paid group.
Technical Analysis Vs. Fundamental Analysis
Technical analysis (the analysis of historic price and volume trends) can be described as a different school of thought than Fundamental Analysis (the analysis of value based on fundamentals).
However, that is a bit like describing peanut butter as the opposite of jelly.
The reality is, although they are totally different things, the analyzing of both technicals and fundamentals are equally important in investing and trading.
Meanwhile, another important concept is Quantitative Analysis.
Definitions of Fundamental Analysis and Quantitative Analysis
Since these are all important concepts, let’s quickly provide definitions for those analysis types:
- Fundamental Analysis is the analysis of fundamentals, for example in the case of cryptocurrencies, mining profitability, transaction fees, transaction speeds, etc.
- Quantitative Analysis is the use of statistics in the process of analysis. This can be used for example to calculate risks, and to figure out statistically where to set buy and sell orders to limit losses and maximize profits.
Other Analysis Types Important to Cryptocurrency Trading and Investing
Further, expanding on the above concepts, a proper analysis should always include other aspects of research such as being aware of trends on social media, being aware of the news, and being aware of trends in the market as a whole.
If a new regulation comes out, if John Mcafee decides to tweet about a coin, if Bitcoin enters a correction, this could override any expected short-term trends a chart might be pointing to.
In crypto many traders and bots trade based only off of TA, thus TA is more important with crypto than it is with other assets. Still, there are some things that you can’t know from charts alone (and even in crypto trading, once in a while it pays to look beyond the charts).
News and events can carry a lot of weight and they should be factored into any analysis.
Putting it Together
Together the above types of analysis are all part of the process of analyzing assets, market sectors, or markets as a whole to better understand the ideal entry and exit points for trading and investing.
Using one or more of those analysis types can then help offer insight into a coin that wouldn’t be immediately apparent.
If you are actively trading, you will very likely want to learn the basics of “TA” (and should at least be doing some basic fundamental analysis as well).
More importantly, and much easier however, you’ll likely want to also follow some smart people who do technical analysis and analyze trends (“those who draw lines on charts”).
Luckily, since not every self proclaimed TA guru is as on point as the next, it helps that posts get up voted, down voted, and commented on on the aforementioned sites. This can help you understand who is giving you some Jedi-like insight into crypto, and who is drawing random lines on charts (whatever the ends of their line drawing may be).
Being a good analyst (or following one online) is a bit like having super powers. It can be the difference between flying blind and seeing the matrix on a good day.
HOWEVER, 1. trends only tell us about probabilities (not certainties) and 2. crypto doesn’t always follow the tends that the charts suggest (as news, odd events, and the winds can throw wrenches in things). Thus, TA is one tool in the tool box, fundamental another, quantitative another, etc. No tool alone is the only tool you’ll need to be successful, and even with every tool you are still dealing with liklihoods.
Still, the better analysts out there end up being right often enough that they are worth paying attention to.
Not only that, but it is also human behavior to look at popular charts and set buy and sell orders based on them. This means that not only do they have predictive power, they have the power of influence.
Let’s say that again. Not only do popular analysts and obvious patterns have predictive power, they have the power of influence.
If everyone sees a head and shoulders pattern forming and expects Bitcoin to dip to $10k, if the popular analysts are charting this, if the trending chart on Tradingview.com predicts this too… then you might want to consider not betting against that event until the trend has been confirmed or not!
That said, always check multiple analyses by multiple traders to get a good sense of the current sentiment on a coin or “trading pair” (for example Bitcoin to Ether).
Further, always put your own strategy and tolerances above what any chart or analyst says. If you are in Bitcoin for the long haul, does it really matter if everyone is predicting a 25% correction (are you really ready to realize your long term gains over a speed bump like that?!)
Bottom line being, if and when the time comes that you get stoked on a chart and decide to take a risk or cash out based on it, make sure it fits your own strategy and even then consider averaging in and out of your positions… just in case the analyst got it wrong or was weeks off on their prediction. No one has magic powers, but a good analysis can none-the-less be a little magical.
TIP: Past trends may not predict future results and a single analyst may be wrong… but TA is really powerful in crypto trading (in fact, it is pretty OP). The reality of crypto is, so many traders and bots trade based on technicals that it is arguably THE single most important aspect of trading crypto. There is a lack of fundamentals and an excess of bots in crypto trading, that paired with everyone (especially the big players) making plays based on trends creates an overwhelming force. That is just the way it is. It is a mistake to ignore the technicals, even a long term investor will want to use them to find good entry points when building an average position (see Fibonacci Retracement levels).
- Technical Analysis. Investopedia.
- Trend Analysis. Investopedia.
- Technical Indicator. Investopedia.