Technical Analysis isn't Magic, but it sure can Enhance Your Crypto Trading

May 29, 2019

As someone invested in cryptocurrencies, you probably follow the crypto markets fairly carefully, you’ve seen quite a rollercoaster ride over the past couple of years.

If you bought in at the right time, you saw your crypto holdings gain tremendously. If you caught the market at a peak, you might be underwater. Most recent crypto investors are somewhere in the middle.

Investing in cryptocurrency can seem daunting, regardless of whether you’re a more active trader or a HODLer. The market is often unpredictable, and trading by gut instinct is often nothing more than a roll of the dice.

To achieve consistent success investing in crypto, it’s necessary to have a strategy, as well as the discipline to follow through with the principles you’ve established.

If that strategy is long-term investing, that’s fine. You’ll need to keep your nerve through the inevitable downturns that the market takes.

More active short and middle-term investing can be profitable in the crypto market too. One of the most powerful strategies for investing in crypto involves the use of Technical Analysis, often shortened to TA.

What is Technical Analysis?

Technical Analysis refers to the use of mathematics and historical data to isolate and identify trends in the market. TA isn’t new to the cryptocurrency world, having been a tool in investors’ belts in many diverse financial markets. The same principles that have made TA successful in other trading arenas make it a suitable tactic for crypto investing.

The nuts and bolts of TA are rooted in mathematical formulas. To become an expert in TA involves immersing yourself and mastering the underlying math. We don’t recommend plunging in that deeply at first, however.

It’s possible to implement TA-based investing strategies without being intimately familiar with how all the indicators, overlays and oscillators are calculated. There are a number of powerful tools available which can help you generate those measures. However, in order to succeed, you must understand the principles of Technical Analysis and how to interpret the indicators.

The Core Principles of Technical Analysis

There are two basic kinds of trading when it comes to a commodity like crypto: Technical Analysis and Fundamental Analysis. The two have polar opposite approaches and are concerned with very different things.

Fundamental Analysis attempts to identify situations where a coin or token is either overvalued or undervalued. A proponent of Fundamental Analysis may use mathematics as part of their approach, but qualitative analysis is often a big factor.

TA, on the other hand, is concerned exclusively with what the numbers are indicating. Rather than trying to figure out the ‘whys’, TA asserts that when ‘x’ happens, this is a sign that ‘y’ is going to happen in the future.

Technical Analysis operates under the core assumption that the price of a given coin or token has all market information already baked into the price.

Expectations of future losses and gains, optimism or pessimism over the future of the coin and its underlying technology, etc – All go into the overall market willingness to buy and sell at a certain price.

Further, Technical Analysis asserts that history is a predictor of the future. In other words, that the market as a whole (and individual investors, on a smaller scale) react in predictable ways. When presented with a set of stimuli, the same reaction usually occurs.

Critics of Technical Analysis are unsettled by the fact that it’s not ‘curious’ as to the reasons why things are happening. For example, a plunge in the market on one day might be due to a report of a major security breach at a popular exchange. The market might plunge on another day because of rumors of a major government considering a crackdown on crypto trading.

To the Fundamental Analysis investor, those are extremely different situations, calling for disparate methods of analysis. But to the TA investor, all that matters are exactly how the price and volume of trading change over time. If the market dropped in exactly the same way each time, the TA investor will treat those situations as equivalent.

The reason TA works is that reactions are predictable, even when outwardly the circumstances might seem different from historical examples.

That’s not to say that TA will unerringly be right every time: If any form of analysis could predict every twist and turn of the market, it would be a solved problem. We’d be able to perfectly anticipate every change in crypto price, which is obviously not the case.

TA, however, identifies trends that generally tend to come true. Like with any trading strategy, there will be hits and misses. But the mathematical underpinning of TA allows for the hits to outnumber the misses with proper application.

Technical Analysis Indicators in the Crypto Markets

There are a host of ways in which TA can be applied to the crypto market. So many, in fact, that an entire article could do nothing but give brief definitions and examples of them all.

That’s not our aim here: Instead, we’re trying to give you a couple of illuminative examples of how TA can help drive investment decisions. Keep in mind that these aren’t the only way to apply TA. But they should hopefully give you a sense of the general way it works.

Japanese Candlesticks

A popular method of TA involves an indicator known as Japanese Candlesticks. This is a charting method that allows users to identify trends in the market based on historical data.

For each trading period (usually, a day), a candlestick is created. The underlying numbers involved are the opening price, the closing price, the lowest price reached during the trading period and the highest price.

A great deal of historical research and backtesting has mapped out certain trends that follow from the occurrence of patterns within a Japanese Candlestick chart. Certain patterns predict a rise in price, while others predict a fall.

Relative Strength Index

Another popular TA technique is known as the Relative Strength Index or RSI for short. RSI falls into a subcategory of TA indicators known as oscillators.

Oscillators fluctuate between 0-100 and are measures of how oversold or overbought a crypto asset is. If the value is high, that means an asset is overbought and due for a downward correction. If the value is low, that means an asset is oversold and due for an upward correction.

Using RSI or other oscillators allows an investor to capitalize on a momentary inefficiency in pricing, to buy or sell in anticipation of the inevitable correction.

We did an in-depth article about what Relative Strength Index is, and how it can be useful for crypto trading. Maximizing on Cryptocurrencies with RSI

These examples are only scratching the surface of the various forms and methods of Technical Analysis. Ideally, though, they give you an idea of how mathematics and historical data can be used to project changes in the crypto market.

The good news is that, if you’re interested in TA, there are a plethora of powerful applications which can help you generate charts for analysis. These apps can range from centered on one form of TA to multi-method analysis packages. They handle the nitty-gritty math, leaving you free to focus on high-level interpretation.

But the bottom line is that Technical Analysis takes practice and study to become proficient in. Trends exist, but isolating them and correctly interpreting them requires knowledge of what the indicators mean.

We hope that this has stimulated your curiosity when it comes to Technical Analysis and that you’ll be motivated to investigate and research further. Please explore one of the many other resources we’ve provided to continue your education and progress to becoming a more skilled investor.

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