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A Beginner’s Guide to Crypto Technical Analysis

How long will the Bitcoin bull run last? How to differentiate between a market reversal and correction?

Burning questions as such can be answered with technical analysis. Technical analysis is the study of charts and patterns to identify investment opportunities.

However, you can gain an edge over the market by equipping a combination of technical analysis strategies that are best suited for a highly volatile market much like cryptocurrency. By analyzing the historical high and low swings, Thomas Fitzpatrick, global head of the company’s CitiFXTechnicals market insight product, forecasted that Bitcoin will reach an all-time high of US$318,000 by December 2021

So, if you are wondering how to conduct technical analysis in the volatile crypto market, read on as we lay out the essentials of technical analysis just for you!

Does Technical Analysis Work on Crypto?

CHAPTER 1
UNDERSTANDING TECHNICAL ANALYSIS

What is Technical Analysis?

Technical analysis is a technique or indicator that uses historical market data to predict possible price movements of a spot or derivatives financial instrument. The underlying assumption of technical analysis is that the price history of the market tends to repeat itself as it reflects overall market psychology.

However, a smart investor will not stop at this juncture; he/she will dive deeper into the analysis to recognize trend lines and come up with trading strategies to ride on the market fluctuations. 

UNDERSTANDING TECHNICAL ANALYSIS

Anatomy of Technical Analysis

The anatomy of technical analysis is best described with Dow Theory. A theory that was developed to better understand multiple variables in the market. There are six tenets to the Dow Theory: 

  • Three types of market movements: Primary movement is the current market movement underway such as bearish or bullish that may last for several months and years. The secondary trend lasts for a period of a few weeks to three months that will fluctuate to the original market value. Lastly, the last trend is the daily movement of stock or crypto price or a short swing due to market speculations. 
  • Phases of accumulation, frenzy, and distribution: During the accumulation phase, investors with first-hand information tend to stockpile cryptocurrencies when the market is quiet. As the everyday investors notice the up-and-rising market trend, investment in the market will increase; thus, leading the market to a frenzy or absorption phase. This is akin to the current bitcoin frenzy as new investors enter the market. Lastly, the distribution phase will occur when early investors spread their stockpile to the public, resulting in a swing in the market.  
  • Market discounts: The third tenet assumes that any information pertaining to the cryptocurrency will be discounted and reflects the market sentiments. For instance, the support of Bitcoin from BNY Mellon, Mastercard, and Tesla has injected confidence in the market and sent the Bitcoin price to a record high.
  • Volume validates trends: In the most simplistic form, the uptick in trading volume should be in parallel with the increase of price. However, if the price spiked without a justifiable trading volume – it is a probable indicator of a pump. 
  • Indexes must conform: Industry indices should move in sync; otherwise, the market trend has yet to be established.
  • Trend is ongoing till reversal: In the stock market, the market trend is assumed to continue until strong signals of a trend reversal. Therefore, the corrections are considered market noise that can be ignored.

Time Frames and Market Sentiments

Apart from the Dow Theory, technical analysts invest based on two other variables: time frame and market sentiment analysis.

The time frames vary from minutes to days or even months to years. Depending on the trading style, traders can choose to open and close positions within selected time frames. For instance, a 5-minute time frame has a significant impact on intra-day traders. However, intraday fluctuations may not have a big impact on daily or weekly charts. 

Market sentiment is the overall consensus of the security market. It is indicated by the CBOE Volatility Index (VIX), or more well-known by its nickname: the Fear and Greed Index. VIX measures the fear, stress or risks in the overall market. If the VIX swings higher than a score of 30, the market sentiment is considered under stress and volatile. 

As the pandemic unfolded around the world in March 2020, the global stock market crashed and the volatility index swelled up to 82 (indicated by the orange trend line). In search of a new haven, investors started to flock into the crypto market and BTCUSD (characterized by the candlesticks) started to climb ever since. 

VIX vs BTCUSD COVID-19

Next, we will dive into the crux of technical analysis and equip you with various techniques to unearth the treasure trove of cryptocurrency investment. 

CHAPTER 2
 A Step-by-Step Guide to Technical Analysis

Ground Zero of Technical Analysis

To streamline the technical analysis process, we have simplified the analysis to three main steps: spotting alerts, forming predictions, and confirming predictions.

A Step-by-Step Guide to Technical Analysis
A Step-by-Step Guide to Technical Analysis

Step 1 – Spot the Alert!

A price visualization chart can quickly alert crypto investors about future market signals. The chart illustrates price reactions using intersections on a linear graph. We will focus on Line Charts, Candlesticks, and Doji Candlesticks. 

Line Charts

Line charts form the foundations of technical analysis and alert crypto traders about primary market movement – bullish or bearish. Using a single continuous line, the line chart portrays a cryptocurrency’s price history over a period of time. The line chart is vital in providing an overview of the cryptocurrency’s price performance and events that trigger the uptick or downtick of prices. 

Beginners may find the line chart useful in analyzing the past performance of a crypto’s trading price and be alerted about the primary market movement. For instance, the following chart shows the price of BTCUSD trended upwards, albeit minor swings, in March. 

Candlestick, Charts and Patterns

An individual candlestick shows high, low, open, and closing prices of a cryptocurrency within a specific period on a price chart. There are two kinds of candlestick red and green. When the candlestick is red, the closing price is higher or the opening price is lower; if the candlestick is green, the price is vice versa. The shadow or wick is a linear line that refers to the high and low of the day. 

Description of bearish and bullish candle

There are also candlestick charts that show upward, downward, and consolidation trends. An upward trend is when the new high price is higher than the previous high price, while a downward trend is when the new high price is lower than the previous high price. However, the consolidation is a mix of downward and upward. 

By analyzing candlesticks over a period, investors will be able to identify candlestick patterns that can be used for buy or sell signals. For illustration, we will interpret some of the must-know candlestick charts: three white soldiers, hammer, and hanging man. 

Three white soldiers pattern is formed by at least triple long green candles consecutively. Additionally, the green candles ought to possess short lower shadows; thus, an investor can interpret the three white soldiers as a bullish signal as it emerges from a downward trend.

Hammer is a candlestick shaped like a hammer with a short green body and long lower shadow. As a rule of thumb, if a hammer appears at the bottom of a downward trend, it signifies a potential upward trend. 

The hanging man is akin to a hammer but appears at the end of an upward trend. This signifies a potential sell-off and bear market signal. 

Doji Candlesticks

Although Doji sounds dodgy, the Doji candlestick is also one of the most popular candlestick types. Doji is usually armed by day and swing traders as it helps assess the highly volatile digital currency market signals. Each of the candles includes data about the open, close, high, and low prices. 

For instance, the Dragonfly Doji has a long lower shadow, and a non-existent upper shadow, which means open, close, and high were of the same level. If you are looking for a buying alert, try to spot Dragonfly Doji at the lowest point of a downward trend. 

Neutral Doji is depicted with a dash in the middle of the body and long upper and lower shadow. It signifies the bullish and bearish sentiments are balanced. As the Neutral Doji shows different market signals at various points, it should be read in conjunction with other technical indicators. 

NOTE:

As cryptocurrency is a volatile commodity, the market alerts can swing from buy to sell within hours. Moreover, as most crypto exchanges have time limits to open or close positions – it is best to strategize by predicting the market movement. 

Step 2 – How to form predictions?

Prediction is an essential part of technical analysis. Applying statistical tools on historical data enables investors to forecast future market movements and strategize the entry and exit price. 

Formation analysis uses various charts to forecast where the prices are leading or the direction of future prices. This term encompasses strange candlestick patterns from the cup and handle to the head and shoulders. 

There is no best candlestick pattern for technical analysis. Instead, a variety of charts should be employed to complement each other such as support and resistance levels, trend, confirmation patterns, reversal, pullback as well as gap. 

Support & Resistance Levels

Have you ever wondered how investors derive buy or sell signals for financial assets? Support and resistance levels are strong predictors of market movements. Support level is a price limit in which the price will not fall beyond. Resistance level is similar to a ceiling that restricts the price from moving upwards. Once the prices break through the support and resistance level, a new trend will emerge – thus, forming a preliminary direction for an investor’s prediction. 

Trend lines are similiar to horizontal resistance and support levels, except that is sloping (in green).

Confirmation Patterns

The confirmation pattern utilizes a few days of data points to find the next trend. Let’s apply what we’ve learned on candlesticks to find a type of confirmation pattern – head and shoulders. 

Combining four data points ­– the opening price, the daily high, low, opening, and the closing price – on a candlestick, crypto investors will be able to determine the neckline, head, right shoulder, and neckline of the head and shoulder pattern. The completion of the candlestick pattern foretells a full breakout of the new trend that was underway. This allows crypto investors to identify the new formation of trends and make suitable investment decisions. 

Another confirmation pattern every crypto investors should learn is the descending triangles. The chart foretells a continuous bearish trend. In August 2019, the descending triangle pattern was identified on ETHUSD Perpetual Contract candlestick chart. The price swings close to the support level, until it gets to a point where a bearish breakout occurs, which would be the signal to sell.

Reversal Patterns

A reversal occurs when the cryptocurrency’s price direction opposes the general direction. For instance, succeeding an upward trend, a reversal will be downwards. 

Reversal trends can appear in the same chart but at different times. For instance, the W pattern is characterized by two low troughs near the support level and one high peak near the resistance level. After completing the reversal, the price of the cryptocurrency is projected to trend upwards, and investors can forecast the next trend by spotting this pattern. 

Despite various oscillations of prices, bullish trends and bearish trends should not be oversimplified with uptick or downtick of price movements. 

A smart investor will look beyond the numbers to understand the underlying driver of the momentum. A bull flag pattern, for instance, is a consolidation of price movements that resembles a flag on the pole. 

Once the consolidation is completed, a bullish breakout is projected to occur. The investors can use this prediction to exit the market at a higher price or invest in assets that are increasing in value. 

In August 2019, a bull flag pattern was spotted on EOSUSD. There was a steep increase in prices, indicated by the green flag pole. Followed by a slide in prices indicated by the flag, the consolidation is completed resulting in a spike in prices.

bearish bull flag EOSUSD

Contrary to popular belief, a reversal can occur on different time frames: days, weeks, or even years. This increases the difficulty to differentiate reversal from brief pullbacks and various noise in the market. 

Reversal vs. Pullback

A pullback is when prices experience an intermediate drop, which lasts for a short period after continuous uptrends. The temporary reversal on market price is also described as retracement or consolidation. 

Are pullbacks opportunities to buy the cryptocurrency? Since the underlying trend is upward, the straightforward answer is yes. However, traders should be cautious if the price has pierced through the support level – which signals a possible trend reversal.

Why is there a Gap?

A gap happens when an event or news introduces a flurry of buyers or sellers into the cryptocurrency market – resulting in a huge price difference between the opening and closing prices. 

There are four types of gaps: common gaps, breakaway gaps, runaway gaps, and exhaustion gaps. 

A common gap (in white) is closed within a couple of days, while a breakaway gap (in yellow) refers to price gaps beyond support or resistance level. The runaway gap is motivated by investors’ intense interest, resulting in trading activity that avoided following price points. Lastly, the exhaustion gap signals the start of a new trend or pattern. 

How are the gaps filled? Gaps are usually filled through a market correction. As playing the gap can be a speculative game, an experienced investor would be more cautious of the volume moved to reduce the market risks.

Analogous to statistical studies, a forecast is akin to a hypothesis and requires further experiments. 

Step 3 – Confirm the technical analysis

Complementing the technical analysis with market dynamics is necessary to validate the forecast. There are two main types of market dynamics, namely indicators and oscillators. 

Indicators

Indicators shed light on market sentiment patterns. It also trends for a sustained period. With the knowledge of how the market is going, investors can then devise investment strategies. Moving averages, relative strength index (RSI), and Bollinger Bands (BBs) are the more well-known indicators. 

Moving average convergence divergence (MACD)

Do not be fooled by the confusing name! MACD is a trend-following momentum indicator that is easy to learn and apply. The MACD shows the relationship between two moving averages of a cryptocurrency by calculating the differences between a longer period exponential moving average (EMA) from the shorter period EMA. 

As a result, the difference is known as the MACD line that can be plotted under a shorter period EMA line to find buying or selling signals. The MACD line can be used in conjunction with candlesticks to confirm the hypothesized technical analysis. 

MACD

Relative Strength Index (RSI)

Relative strength index is an investing technique of buying high and selling even higher. The technique encourages investors to handpick security that is outperforming the market benchmark. Applying this indicator, investors assume that the upward trend will continue.

Technical traders can use the relative strength index (RSI) is a momentum indicator that finds the overall price changes in a short period to analyze the conditions of the security. For more in-depth technical analysis, the RSI should also be used to confirm the forecast from candlestick patterns.

RSI

Bollinger Band

As the name suggests, Bollinger Band is an indicator that allows the upper and lower width of the price band to move in tandem with the price fluctuations of security. The Bollinger band is measured by simple moving averages. Once the price moves out of the band, a price reversal may be imminent. 

Oscillators

Oscillators are momentum indicators used in technical analysis, whose fluctuations are bounded by the upper and lower band. Oscillators are broadly used for the discovery of brief conditions such as overbought and oversold. 

In other words, oscillators allow opportunists to ride on trends. The main difference between oscillators and indicators is that the former can remain in the state of oversold or overbought for extended periods (but not sustainable). 

There are two categories of momentum: relative and absolute. In relative momentum, traders would contrast various cryptocurrencies to see whether they can outperform the rest or perform much worse.

The second approach is absolute momentum; it occurs when traders analyze the price of a cryptocurrency individually and contrast the current price of the coin with its historical performance. Therefore, allowing investors to verify the projected numbers in technical analysis. 

Stochastic RSI

Similar to RSI, Stochastic RSI applies an oscillator formula to measure the market sensitivity. 

To give an illustration, Stochastic RSI contrasts the most recent closing price to a range of its previous prices in a given period. This will indicate to the traders whether the asset is overbought or oversold. 

Most importantly, Stochastic RSI allows traders to identify whether an asset is in the overbought (80) or oversold (20) territory. As it works best in a volatile market, Stochastic RSI can pinpoint the end of a pullback.

Commodity channel index (CCI)

Another popular momentum oscillator is the commodity channel index (CCI). The CCI is used for determining the strength of a trend. The CCI finds the differences between the current and historical average price for a given period. 

CCI also oscillates between -200 to +200. If the CCI is more than zero, it indicates that the market price is above the historical average and the market is bullish. Conversely, should the CCI be less than zero – it is underperforming, and the market is bearish. 

Despite its popularity in predicting price movements, technical analysis is being criticized as a self-fulfilling theory. Fortunately, crypto investment is kindred to equity investment by utilizing the same fundamentals.

Commodity Channel Index

CHAPTER 3
Pitfalls of Technical Analysis

Technical Analysis is subjective

Technical analysis is not a foolproof strategy, and interpretations of the charts and patterns can be very subjective. For instance, investor A may spot a head and shoulder pattern, while investor B may interpret a W-pattern within the same time-frame. 

With FOMO rally running high in the crypto community, optimistic investors will also be easily tempted to join the century’s virtual gold rush. To prevent hindsight errors as such, it is crucial to validate the information received with a different persona to gain a broader perspective on the market. 

Pitfalls of Technical Analysis
Pitfalls of Technical Analysis

Risk of historical data

Much like the typical statistical tools, the technical analysis seeks to quantify the causation links between the historical numbers. Since the cryptocurrency market is highly volatile, it is prone to market manipulation and reduces the accuracy of past data. This is the reason volume trading is to be used with caution. Of course, the cryptocurrency requires a certain trading volume to move, but solely analyzing volume is not a comprehensive trading strategy.

Even with a complete set of data, some market fluctuations are also unpredictable. The COVID-19 pandemic, for instance, is characterized as a black swan event that is highly unpredictable and has an adverse impact on the global economy. 

Pitfalls of technical analysis

Inconsistent Forecasts Methods

Often, beginners will use irregular time frames and inconsistent technical analysis techniques to analyze the market price fluctuations. This will result in mixed market signals and inaccurate investment strategies. To improve the accuracy of a forecast, beginners can conduct a technical analysis of the same time frame and test out various technical analysis techniques that are most sensitive to the security’s price. 

A mismatch between risk appetite and investment strategy

Risk appetite is a significant element of investment that is frequently ignored. Investors must always remind themselves that risk and volatility are different. Volatility increases the chances of winning and losing exponentially, while the risk will diminish the returns. 

Depending on various factors – the ability to regenerate wealth, personality, liquid assets, and more – risk appetite differs for every individual. If investor A has a low-risk appetite, he/she should try to avoid securities with huge swings. 

 Is Technical Analysis dead?

Technical analysis is not a sham. However, it has to be used with other analysis methods such as fundamental analysis to reduce the limitations of technical analysis and achieve the best cryptocurrency trading results. 

CHAPTER 4
REMEDIES TO THE PITFALL

“I will tell you how to become rich. Be fearful when others are greedy and greedy when only others are fearful.”

WARREN BUFFET

Remedies to the pitfalls

A combination of technical and fundamental analysis

Before you start charting the way to the next gold mine, investors ought to combine various analysis techniques such as fundamental analysis to avoid subjective biases. 

Fundamental analysis involves analyzing financial statements to determine an asset’s intrinsic value, while technical research focuses on determining the future price using market price movements in the market. For illustration purposes, Investor A can determine the company’s financial ratios and analyze its market price movements on TradingView before buying its security.

Tools for Technical Analysis

TradingView offers investors a platform to chart out the patterns such as MACD and RSI. Additionally, Bybit Testnet is a user-friendly platform that provides a way for investors to test their strategy in a virtual environment before a real investment. 

Choose a safe crypto exchange

Most importantly, investors should opt for exchanges that provide 24/7 customer services and stop-loss to safeguard their interests. Bybit offers 100,000 transactions per second (TPS), 24/7 live chat, stop-loss, strategy alerts, and leverages for investment. 

Remedies for technnical analysis pitfalls

Exit and review

Due to exuberance, first-time investors are inclined to believe that the security will continue to appreciate in a bullish run. Therefore, investors should consider the option of early exit or partially closing the position before a complete reversal occurs. 

After exiting, investors should also review its investment strategies by journaling the trades and tweak the multiple analysis to suit your investment style.

Important Note:

However, we are not financial advisors, and this information should not be considered investment advice. This material is for educational purposes only. You should never invest more than what you are ready to lose. 

CHAPTER 8
BONUS CHAPTER

Technical analysis for crypto derivatives is similar to spot tradings. Often, a crypto investor will apply technical analysis such as candlestick pattern analysis on crypto derivatives. 

Most recently, a bearish engulfing pattern was spotted on Bitcoin CME Futures. A bearish engulfing pattern occurs when the red candlestick eclipses the green candlestick of the previous day after the peak of an uptrend. Investors can forecast a pullback and short for lower prices of Bitcoin to make a profit. Shorting is a common strategy adopted by investors that anticipates a fall in cryptocurrency’s price for a short period in the future. 

How to apply Technical Analysis on crypto derivatives?

Applying Technical analysis on crypto derivatives
Applying Technical analysis on crypto derivatives

A different investment strategy for crypto derivatives

As such, a different investment strategy can be opted for the crypto derivatives market. 

Ever since the launch of Bitcoin Futures Contracts by the century-old Chicago Mercantile Exchange (CME), crypto investors are able to adopt a net-neutral strategy. The investment strategy refers to seeking profit from both the increase and decrease of an asset’s price while attempting to avoid specific market risks. 

As there was a lack of alternative financial instruments to short the crypto market, it led to an overheated scene and the Bitcoin Bubble 2017. In fact, Gary Cohn, National Economic Council’s Director, believed that the crypto bubble was deflated by – the launch of bitcoin futures. 

RECAP

There are some things you should know to become a smart cryto investors:

Learn the pros and cons of technical analysis
Use complementing technical indicators
Identify the market signal, spot the underlying market trend and strategise
Avoid the pitfalls such as confirmation bias
Be critical about all the market information received (even if is a tweet from Elon Musk)
Review analysis techniqies and investment strategies frequently

Bottomline

Just like every coin has a flip side, technical analysis has its benefits and drawbacks. Technical analysis uses statistical techniques to make sense of historical market price movement and chart out possible entry and exit market strategies. 

However, fundamental analysis can strengthen the technical analysis and allow investors to make a better decision before joining the FOMO rally. Are you ready to apply the newfound knowledge? Click here to learn more about risk management techniques. Or sign up for our newsletter to learn tips and tricks of trading in the crypto market!