Technical analysis is one of two general approaches to studying and trading the cryptocurrency markets. The other approach is fundamental analysis. Both are equally valuable and worth exploring, as we shall discover in this article.
Technical analysis confines itself to the analysis of market price action and related data (e.g. volumes) over time. Through patterns deciphered by reviewing charts and mathematical indicators, insights can be gleamed on future market behavior, enhancing trade entry and exit precision.
Commonly observed charting patterns include Head and Shoulders Top/Bottoms, Double/Triple Top/Bottoms, Rectangles, Triangles, Wedges, Channels and Flags/Pennants.
Candlestick chart patterns are also helpful to analyze, as are popular Mathematical Indicators like Moving Averages, Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), Bollinger Bands along with Fibonacci Retracements.
Some technical analysts utilize Point and Figure charts, Elliot Wave Theory, Gann, Market Profile and other indicators, but discussion here will be limited to the most popular indicators, which already provide fairly robust trading signals.
Fundamental analysis or technical analysis
Technical analysis complements and should not be a substitute for fundamental analysis. Most successful traders apply both types of analyses. Fundamental analysis discussed in the context of how it applies to FX markets generally involves the study of a country, industry sector or company’s future earnings prospects, based on macroeconomic, sector and company-specific conditions.
As with fundamental analysis, technical analysis is not 100% reliable. Technical analysis is often criticized as being an art form, rather than a science. The key is to not rely solely on technical analysis, let alone on one mathematical indicator or charting pattern. Studying a combination of trends, different charting patterns and mathematical indicators across Multiple Time Frame Analysis provides a base from which to make trading decisions. This understanding must be supplemented with an appreciation for market fundamentals and general trading principles.
Technical analysis has fairly broad application. It can apply to any asset class (i.e. cryptocurrencies, equities, commodities, fixed income and FX) whose pricing is determined by supply and demand. Technical analysis also works within any time frame. Interpretation of charting patterns and mathematical indicators remains fairly consistent across most time frame charts, whether data is plotted every hour or once a week.
However, the longer the timeframe, the more reliable the technical analysis, as the greater the liquidity reflected in the price action. As practitioners of technical analysis from the 1970s through early 1990s did not generally have access to software that could generate the mathematical indicators, the earlier adopters of technical analysis tended to focus on charting patterns as opposed to mathematical indicators. Many of these individuals to this day continue emphasizing the importance of charting patterns over mathematical indicators. Technical analysis to the untrained eye may often appear overly subjective, but the reality is, enough traders often apply technical analysis in a consistent manner to generate self-fulfilling trade signals.
Key assumptions of technical analysis
- Price action incorporates all public and nonpublic information (including forecasts, expectations and sentiment)
- Prices move in trends or persistent patterns
- History repeats itself
When investing in crypto over a longer time frame and without any leverage, timing an entry into or exit from a position is less crucial. However, a trader who buys and sells several times a week or day, will often use leverage to produce the desired income. Such leverage introduces substantial risk, especially when trades are timed poorly. Technical analysis assists with such timing and helps brings precision to entry and exit.
This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.
WRITTEN BYDarren Chu, CFA
Darren Chu, CFA, is the founder of Tradable Patterns, publisher of daily technical analysis on Bloomberg, Thomson Reuters, Factset, Interactive Brokers, Inside Futures, and other partner websites. Before the launch of Tradable Patterns, Darren served as IntercontinentalExchange | NYSE Liffe's country manager for Australia, India, and the UAE, expanding his role to look after Liffe business development in APAC ex-Japan/Korea until his departure mid April 2014. Previously, Darren was with the TMX Group | Montreal Exchange, marketing Canadian futures and options across North America, London, Singapore and Hong Kong. Darren also launched and managed CMC Markets Canada's Chinese marketing and sales team, along with educational offering. Visit www.tradablepatterns.com for more information.