What is it?
Technical analysis is the systematic evaluation of price, volume, breadth, and open interest, for the purpose of price forecasting. It is used in conjunction with, or as an alternative to fundamental analysis. Technical analysis is often used when trading cryptocurrencies such as BTC or ETH due to the large volume of trades which can often signal trends and predictable behaviour of prices.
It is the short-term price movements caused by anticipation (rather than actual events), extreme volatility, prices that are seen as far from value, countertrend systems that rely on prices reversing direction, and those that attempt to capture trends of less duration that are the primary focus of technical analysis.
Strategy of Trading:
The strategy of the trader can first of all be decided by whether one wants to trade intra-day or longer term. If you are a long-term, macrotrend follower, then you want the price series that shows more trends, which are improved by monthly, weekly, or daily charts, although monthly is generally too low frequency for traders. Short-term traders focus on mean reversion or fast directional price moves, and that strategy is enhanced using higher frequency data, such as hourly or 15-minute bars.
The proper assessment of the price trend is critical to most trading systems. Countertrend trading, which takes a position opposite to the trend direction, is just as dependent on knowing the trend as a trend-following technique. A significant number of trend-predicting models have been accurate and successful. Prices also move on anticipation. When most traders hold the same expectations, prices move quickly to that level. Prices then react to further news relative to expectations.
These are used to highlight support and resistance levels during the current trend in price. Trend is upward/downward or roughly horizontal. Support and resistance levels are price levels where there’s an increased probability that there will be either a slowdown or reversal of the current trend. Support trendlines are drawn by joining troughs in a straight line and resistance trendlines are drawn by joining peaks.
How to plot support and resistance lines:
1. Identify all/most highs and lows, no need to go back more the 8 months maximum
2. Connect highs/lows with horizontal lines (doesn’t have to be exact)
3. Key resistance is main horizontal line at the top, key support is main horizontal line at the bottom. Key resistance means it is significant for price to break it, leading to large changes. It holds on if the price tests it but doesn’t break it
4. Short term resistance is easier to break and leads to less major price changes
5. Support trendlines drawn by joining troughs in a straight line, resistance by joining peaks. Buy at support, sell at resistance. Or, buy if price aggressively breaks resistance, remembering to put a stop order just above it.
6. Value areas are where the price often tends to end up, and can have support/resistance lines drawn through them
7. Wait for a key level to break, then wait for price to retrace back to it and look for a price action setup entry trigger to form near the breakout level in the direction of the initial breakout.
8. Lesson: trust your stops if you’ve placed them beyond a key support or resistance level or in another logical place.
EMA: exponential moving average: a type of moving average (MA) that places a greater weight and significance on the most recent data points. An exponentially weighted moving average reacts more significantly to recent price changes than a simple moving average (SMA), which applies an equal weight to all observations in the period. This means that it reacts quicker to recent changes in price than SMA. The weighting given to the most recent price is greater for a shorter-period EMA than for a longer-period EMA.
Like all moving averages, this technical indicator is used to produce buy and sell signals based on crossovers and divergences from the historical average. The 12- and 26-day are used to create indicators like the moving average convergence divergence (MACD) and the percentage price oscillator (PPO). In general, the 50- and 200-day EMAs are used as signals of long-term trends. When a stock prices crosses its 200-day moving average, it is a technical indicator that a reversal has occurred
Moving Average Convergence Divergence (MACD):
This is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.
MACD is often displayed with a histogram (see the chart below) which graphs the distance between the MACD and its signal line. If the MACD is above the signal line, the histogram will be above the MACD’s baseline. If the MACD is below its signal line, the histogram will be below the MACD’s baseline. Traders use the MACD’s histogram to identify when bullish or bearish momentum is high.
Source: Trading View Chart, Profit Confidential
The relative strength index (RSI) is a momentum indicator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset. The RSI is displayed as an oscillator (a line graph that moves between two extremes) and can have a reading from 0 to 100. The indicator was originally developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, "New Concepts in Technical Trading Systems."
An asset is usually considered overbought when the RSI is above 70% and oversold when it is below 30%. This can be used to determine whether the asset is over or under-priced, signalling whether it is bullish or not.
Source: Trading Setup Review
It is important to note that using technical analysis does not guarantee profitable results, nor is it accurate all the time. Traders must act in the knowledge that their assets are at risk, and there is little protection from large price volatility, especially if leverage is used. Risk management is vital, so using stop losses, constant vigilance and anticipation is important. Black swan events are not as rare as one would think in crypto.