With the recent boom in the crypto industry, many are exploring ways to earn from cryptocurrencies. A familiarity with technical analysis is important if an investor wants to trade cryptocurrencies. Whether they plan on trading cryptocurrencies actively or want to invest in them for the long term, understanding and learning how to properly use technical analysis is essential.
- Technical analysis is also relevant in the crypto market, and the same principles apply.
- By using technical indicators to analyze crypto charts, traders and investors can learn what the emotion of the market is and how the prices of cryptocurrencies will be affected.
- The key to making a good trading decision is primarily based on understanding the market trends in crypto charts and how to capitalize on them.
What Is Technical Analysis?
Technical analysis is the process of using historical price data to attempt to forecast the likely future direction of price. The technician has many tools at their disposal. All are derived from price and/or volume. Through the study of historical price data that is plotted on charts, the technician is able to make a judgment about the sentiment of market participants.
These technical tools can be used with a wide variety of securities such as stocks, indices, commodities, or any tradable instrument, including cryptocurrencies.
A Brief History of Technical Analysis
Charles Dow (1851–1902) is considered to be the father of technical analysis. He was the first editor of The Wall Street Journal. In 1882, Dow and Edward Davis Jones formed Dow, Jones and Co. as a Wall Street financial news bureau. The following year, they put out a two-page summary of the day’s financial news, called the Customer’s Afternoon Letter. Included in the newsletter was the Dow Jones Index, which consisted of 11 stocks: nine railroad issues and two non-rail issues.
In 1889, the partners decided to transform their newsletter into a full-fledged financial newspaper, and The Wall Street Journal was born. It has been published continuously since that date. Charles Dow was the first editor. The editorial column in the Journal educated his readers about the stock market. It was in this column that he would often write about his observations of stock price movements. These observations became the foundation of what was to be called Dow Theory and is the foundation of what we now know as technical analysis.
What Is Dow Theory?
Even though Dow Theory has been around for more than 100 years, its principles still apply to today’s markets. Dow Theory describes market trends and how to identify them. In 1916, Dow increased the number of companies in his index to 20.
As larger corporations began to emerge in the 1890s, Dow created the Dow Jones Industrial Average (DJIA). When it was created In 1896, it included 12 corporations. Dow would make a note of the closing price of all 12 corporations, add them up, and divide by 12 to come up with the average.
The original index of rail stocks had two non-rail stocks, Dow replaced these two non-rail stocks with rail stocks, and the Dow Jones Railroad Average (DJRA) was born. In 1970, when the average was changed to the Dow Jones Transportation Average (DJTA), the rail stocks were replaced by airline and trucking stocks.
Because industrial output requires some form of transportation to move the goods to customers, Dow observed that for a trend to be valid, the two trends must be moving in the same direction. When industrial output is up, the railways are busy and both indices should be up. When industrial output is down, the railways will be less busy and both indices should be lower. Transportation of goods is now done by trucking and airline companies. Hence, the DJIA and DJTA must confirm for a trend to be valid.
Principles of Dow Theory
Dow Theory is based on six principles:
- Price of assets incorporates all information: The market incorporates all information about assets in the assets’ prices. All information relating to an asset, such as the profit potential and competitive edge, is already incorporated into the price of an asset.
- Three primary kinds of market trends: The bull and bear market are the primary trends of a market. The secondary trends of a market are usually against the primary ones; they include corrections in bull markets and rallies in bear markets.
- The primary trends have three phases: The primary trends undergo three major phases. For the bull market, this includes the accumulation, public participation, and excess stages. The bear market, on the other hand, passes through the distribution, public participation, and panic stages.
- Market indices must correlate with each other: Signals from one market index must correspond to signals from another for a new market trend to be confirmed. If one market index is signaling a new primary downtrend and another is signaling a primary uptrend, a new market trend has not begun. But if both indices signal the same upward or downward trend, traders can confirm that a new market trend has begun.
- Market trends should correlate with corresponding volumes: In a bull market, market volume should increase accordingly. In a bear market, market volume should decrease over time. If the market volume decreases in a bull market, it could signify a bearish movement that could lead to a bear market.
- The trend persists until a clear reversal occurs: Market trends are continuous until a definite reversal occurs. Regardless of fluctuations in the daily price movements, Dow Theory emphasizes that a market trend will persist until a definite reversal happens.
Charts are the main tool of the technician. There are different types of charts. Their purpose is to provide a visual representation of price action.
Line charts are the most basic type of chart used in technical analysis. They usually use only one data point: the closing price. To identify the trend, a series of closing prices is plotted on a chart and joined to form a line.
Bar Charts (Open High Low Close Chart)
Bar charts contain more information than line charts. The open, high, low, and close are used for every bar that is plotted on a chart. These charts are often called OHLC for open high low close.
These charts originated in Japan in the 1700s and were first used by rice merchants. They were introduced to the West by Steven Nison in his book Japanese Candlestick Charting Techniques. Like bar charts, candlesticks use the open, high, low, and close, but their depiction is more visual and has become popular among all traders. In fact, candlestick charts are one of the most popular charts used in the West and are available on all trading platforms.
Candlesticks are popular among cryptocurrency traders and are used in the same way as traders use them for other securities. For short-term traders, there are charting services that will provide time frames from intervals of as little as one-minute charts and various intervals up to daily charts. For the longer-term trader, daily, weekly and monthly charts are useful.
Each candle has two parts: the body, and the shadows or “wicks.” The body indicates the difference between the opening and closing price of the crypto coin in a time interval. The top wick shows a cryptocurrency’s highest price during a time interval. The bottom wick reveals the lowest price of the crypto asset in a time interval.
A candlestick can be bearish, appearing as a red-colored candlestick, or bullish, appearing as a green candlestick. A bullish candlestick has a higher closing price than its opening price, while a bearish candlestick has a higher opening price than its closing price. When read correctly, candlestick crypto charts can help you see patterns in market trends so that you can predict possible future outcomes.
Support and Resistance Levels
Support and resistance levels are important levels recognizable on a chart, where supply and demand meet. Learning to recognize these levels can help the trader with successful entries and exits.
When the level of demand rises to match the supply of a crypto currency or other security, then the price of the asset in a downward trend will stop falling. This level is known as support and will be tested several times by traders. If the support level does not break after several tests, then traders are more comfortable to enter long trades. Sometimes, however, the support level will be breached and prices will move lower. When this happens, prices will continue lower until a new support level is found. The prior support level often becomes a new resistance level.
Resistance levels are made when supply matches demand. In an uptrend, prices will rise until they reach a level where demand no longer outpaces supply. As prices get to this level, more traders are willing to sell. There is more supply than demand, creating a ceiling over prices. These levels will often get tested multiple times. Successful tests of these levels often mean that traders are now more comfortable shorting the security. Sometimes, however, prices will break through resistance and continue higher. When this happens, prices will continue rising until they find a new level of resistance. As with support, the old resistance level will often become new support levels.
All markets move in trends. There are three main trends. Markets can move upward in an uptrend, downward in a downtrend, or sideways in a channel or consolidation.
Uptrends are identified when prices reach higher highs and higher lows. The trend can be plotted on a chart. The convention is to draw an uptrend line under price, linking the lows. Some traders will use a moving average to identify the trend in lieu of drawing trend lines.
Downtrends are identified when price makes a series of lower lows and lower highs. The trend line is drawn above price by linking the price highs. It is also acceptable to use moving averages in lieu of drawing trend lines.
Sometimes during an uptrend or a downtrend, the market will oscillate sideways within a narrow band. These are often dull markets and are sometimes called consolidation trends. Different trading rules apply to these types of markets.
Understanding Technical Indicators
Traders use many technical indicators to gain greater insight into a trend. There are indicators that are plotted over price, like Bollinger Bands, and those that are plotted in panels above or below price, like the moving average convergence divergence (MACD) and the relative strength index (RSI). There are also indicators that use volume, like the on-balance volume (OBV) indicator. All indicators, no matter how they are plotted, are derived from price and/or volume. Therefore, they should only ever be used in conjunction with price. Confirmation should always come from price.
Moving Average Convergence Divergence (MACD)
The moving average convergence divergence (MACD) is one of the most popular and well-known indicators. It was developed in the late 1970s by Gerald Appel. This indicator is plotted with two lines:
- The MACD line, which is the difference between the 12-day exponential moving average (EMA) subtracted from the 26-day exponential moving average
- The signal line, which is the nine-day EMA of the MACD
The two lines fluctuate around a center line, which is at zero. There is no upper and lower limit to the indicator.
The most common use of the MACD is for signal line crossovers. The signal line trails the MACD line. When the MACD line turns up and crosses the signal line, that is bullish. When the MACD turns down and crosses the signal line, it is bearish.
Relative Strength Index (RSI)
Another popular indicator is the relative strength index (RSI). This indicator was developed by J. Welles Wilder. The RSI is bounded and fluctuates between zero and 100. It is a momentum oscillator that measures the speed of price movements. Default settings are 70 and 30. When the oscillator is above 70, the security is considered overbought. When the RSI drops below 30, the security is considered oversold.
Bollinger Bands are volatility bands placed above and below a moving average and plotted on price. They were created by John Bollinger. Volatility is based on the standard deviation. The bands that often will encompass price expand and contract as volatility expands, and decreases are based on +2 standard deviations above the center line and -2 standard deviations below the center line.
The interpretation of price action depends on the trading environment. In bullish conditions, it is often more profitable to trade in the direction of a price breakout. In bearish markets, short in the direction of the breakout. The idea behind Bollinger Bands is that prices eventually will return to the mean. Periods of high volatility eventually will become periods of low volatility.
On-Balance Volume (OBV)
The on-balance volume (OBV) indicator was developed by Joe Granville. It measures buying and selling pressure using volume rather than price. Granville surmised through his observations that volume precedes price. The OBV, therefore, is a running total of cumulative volume. When the volume on up days outpaces volume on down days, the OBV rises. When the volume on down days outpaces the volume on up days, the OBV falls.
Where to Find the Crypto Chart
Once you have a basic understanding of how to read a chart, the next step is to learn where to find crypto chart tools and what to look for.
TradingView is a popular site where crypto companies and investors can find live trading charts for crypto. A free version and a premium version are available on the website.
The features available on Coinigy help investors to understand market sentiment. It’s a cloud-based platform, as well as data from other cryptocurrency exchanges. It offers a free plan as well as a few paid options.
A popular crypto charting and trading terminal is Cryptowatch. It is owned by the Kraken exchange. The tool allows you to analyze market movements and make trades on major crypto exchanges. The service is free.
What Exactly Does a Crypto Chart Show?
Investing in cryptocurrencies requires understanding of what data to look for on a crypto chart. There are a few basic parameters to consider when assessing the performance of a cryptocurrency.
- Price: Checking the price of a cryptocurrency is the first step in checking its performance. By using the technical indicators listed above, an investor can determine what’s trending. Comparing price movements with past days, weeks, months, years, and all times are some of the tools necessary to understand before investing.
- Market cap: The market capitalization of a cryptocurrency is calculated by multiplying the price of each token by the number of circulating coins. A comparison can be made with the data over the past few days, weeks, and years.
- Trading volume: This refers to the number of times that a coin changes hands during a certain period of time. If it’s expanding, that means more and more people are buying the coin.
- Hashrate: It is the speed of mining a cryptocurrency. In other words, it measures how many calculations can be completed in a second in units of hash/second. It’s a good sign if the hashrate is higher because that means a large number of miners are verifying transactions, and hence the cryptocurrency is more secure.
- Circulation supply: In general, circulation supply refers to the number of coins or tokens that are actively traded and used in the market and by people. The price of coins will depreciate if the supply is high and the demand is low.