Technical Analysis Primer

There are two ways traders and investors make sense of the markets: Fundamental analysis, and Technical Analysis.

  • Fundamentalists look at real world events; earnings and cash flow for stocks, rental yields for real estate, and economic and political events for Forex.
  • Technicians read the chart to analyze investments based on historic price action.

Some think Technical Analysis is mumbo-jumbo, like reading tea leaves or astrology—charting constellations all the way to the moon!

But, Technical Analysis is a key part of any traders toolkit, especially in the cryptocurrency market which lacks fundamental factors like cash flow or rental yield.

Though Technical Analysis is more of an art than a science, it is based on the proven idea that history tends to repeat itself.

By identifying recurring patterns, technical analysts can figure out points where the price is likely to change direction, and calculate the probability of different price movements.

Japanese Candlesticks

The Japanese began using Technical Analysis to trade rice in the 17th century, and devised the system of Japanese Candlesticks to represent price action.

Each candlestick represents a specific period of time and a range of price movement.

There are four components to the candlestick: The opening price, the highest price in the period, the lowest price in the period, and the closing price.

By Pascarella Giuseppe from Italy., CC BY-SA 3.0, httpscommons.wikimedia.orgwindex.phpcurid=611574
Source: Pascarella Giuseppe

The body of the candlestick represents the range between the open and closing prices of the time period the candle represents.

  • A black or red candlestick means the closing price during that time period was lower than the opening price, and a green or white candlestick means the opening price was lower than the closing price. 
  • The wicks—or the shadows—represent the extremes of price action during that period.

These candlesticks form recurring patterns with poetic names—like shooting stars, bullish engulfing candles, and spinning tops—which represent bullish, bearish, or indecisive price action.

When indecision candles appear at a support or resistance level, technical analysts might decide to take a trade.

Support and Resistance Levels

If buyers or sellers have stepped in at certain price levels in the past, then technical traders might use these areas to anticipate where price might change direction in the future.

These levels are known as support and resistance, or supply and demand, and represent one of the most widely used technical trading techniques.

SR
Support and resistance

As shown on the chart, when the price moves up to a level and then bounces back, this area can be said to be acting as resistance. And when the price is falling, where it eventually stops is said to be support.

These support and resistance levels are not exact numbers, but tend to be rough areas based on historical price action, or big round numbers—like $10,000 for BTC.

When buyers overpower sellers at a resistance level and the price breaks upwards, this can trigger a large move as those who were betting against the price scramble to buy the asset to cover their short positions.

On the opposite side, when sellers overpower buyers at a support level and the price falls down, this can also trigger a large move as those who had open long positions quickly sell.

These areas also switch between acting as support and resistance: When price revisits an area that previously acted as resistance, it might break through and then the same area will act as support. This is known as a support/resistance flip.

Along with horizontal areas of support and resistance, technical traders might also look for diagonal trend lines.

Trend Lines

trendlines
Uptrend and downtrend

Just like horizontal support and resistance areas, trend lines represent areas where buyers or sellers could be expected to step in and change the direction of the price.

These diagonal lines are drawn by connecting the peaks and valleys where the price has previously turned around. 

In an uptrend, a trend line is drawn along the bottom of the support areas, and in a downtrend, a trend line is drawn along the tops. 

Patterns

When you draw horizontal support and resistance areas and diagonal trend lines on the chart, you might find that familiar shapes appear.

Triangles, wedges, head and shoulders patterns, and double tops—all of these are patterns recognized by classical technical analysts.

Each pattern is either bullish or bearish, suggesting that the price is likely to move up or down when the pattern is complete.

pattern
A descending triangle forms on the bitcoin chart
patterncomplete
A few days later, price drops through the support level

 

Moving Averages

Moving Averages take the average closing price of the asset for a set number of candlesticks, and represent this as a line on the chart. 

This is used as a way to smooth out price action over time to show trends and determine possible areas of support and resistance.

movingavg200weeks
Bitcoin found support at the 200 week Moving Average in the bottom of the 2018 bear market 

The longer the period of time that the Moving Average takes into account, then the smoother it will be, and the slower it will react to new price movements.

So what are you waiting for? Go to TradingView, open a price chart and start to apply your own Technical Analysis.

Disclaimer: The material in this blog post is not financial advice. Trading involves substantial risk of loss.