If you’ve spent a little while in the blockchain space, you’ve likely heard people talking about technical analysis, or ‘TA.’ Many who perform TA gather huge followings over on crypto Twitter or Reddit, where they showcase their predictions to their followers.
Although no one knows which way the market is truly going to go, technical analysis is a great way to assess the price action and trend on a cryptocurrency chart. TA also enables you to pick a good entry or exit point for your positions. But first, let’s explore what technical analysis actually is.
What is Technical Analysis?
Technical analysis of cryptocurrencies is done by analysts to predict the price action and direction of a coin in the future. Technical Analysis is based on the coin’s historical prices and volume, and the analysts hope to predict accurately whether the currency should be bought, held, or sold. In short, TA experts believe that past trading of an asset can indicate its future price movements.
Adept technical analysts have been able to generate handsome profits with the expected volatility that occurs in crypto markets. There are also technical analysis systems and automated trading software which rely on technical indicators to do trades and generate profits.
Most TA trading strategies are based on the assumption that cryptocurrency markets move in trends. We’ll look at some of these trends later, such as moving averages, but essentially, TA experts believe that crypto prices will generally follow short, medium and long term trends which have occurred cyclically in the past.
While the crypto market may seem erratic on a daily basis, cryptocurrencies do tend to all follow a broader trend, known as a bull or bear market, just like traditional securities markets.
It’s important not to get technical analysis confused with fundamental analysis – which focuses on the principles, business practices, team, and finances of a cryptocurrency project rather than solely its trading history. For long term investments, in the space of months to years, you may want to look more closely at fundamental analysis rather than just technical analysis.
Here are our top 6 indicators for crypto trading and technical analysis:
Moving averages are the simplest and the most widely used technical indicators. The moving average, as the name indicates, is a moving mean that is calculated from a subset of the coin’s historical prices over time.
For instance, if the period is 3, the first value of MA will be the average of the first three crypto prices; the second value will be the average of second to fourth values of the crypto; and so on. In case of cryptocurrencies, there are various moving averages, such as the simple moving average (SMA), exponential moving average (EMA), weighted moving average (WMA), and volume moving average (VMA).
Traders use these moving averages to understand the price trend and make trading decisions accordingly. They are used alongside other technical indicators to improve the accuracy of the prediction. As moving averages are displayed as a smooth line on a chart, they make it easy to identify the direction of a price trend. Volume moving average is different from the others in that it’s not based on price, but instead on a coins trading volume.
Relative Strength Index (RSI)
RSI is an indicator that oscillates between 0 and 100. This indicator attempts to predict whether a currency is overbought or oversold. The idea is, if the coin is overbought, there is a potential for it to fall. To determine RSI, you need to calculate the relative strength (RS) as the ratio of average gain and average loss.
Usually, a cryptocurrencies past 14 periods are used to calculate average gains and losses. When RSI is above 70, the coin is supposed to be overbought, which means the price could begin to fall; if the RSI is below 30, the coin is said to be oversold and could begin to rise.
Moving Average Convergence Divergence (MACD)
MACD is one of the most widely used and trusted absolute price oscillators out there. It attempts to predict price action by analyzing two exponential moving averages: short-term (12-day) and long-term (26-day) alongside a signal line (nine-day EMA). The predictions are made by examining the crossovers of the three lines. This dependence on three price periods is supposed to give better-than-average accuracy to MACD predictions.
Cryptocurrencies have support and resistance levels which, when broken, often leads to the price moving significantly lower or higher. The stochastic oscillator is based on these support and resistance levels. Like RSI, stochastic oscillator also ranges between 0 and 100. When the oscillator moves above 80, it signals overbuying, and therefore, the coins price is expected to come down. Similarly, values below 20 signal overselling and an increase in price.
Bollinger bands are a type of indicator that is drawn over the price chart to indicate its volatility. This indicator consists of three lines:
- A median line (usually a 20-period exponential moving average)
- An upper curve (median curve + twice its standard deviation)
- A lower curve (median curve – twice its standard deviation)
These bands expand and contract, signaling the volatility of the coin’s price. For instance, when the bands contract, a less volatile, steady price movement is indicated. Expansion of the bands signals a more volatile situation. Also, the price touching upper and lower bands indicate overbuying and overselling, respectively.
You should use Bollinger bands along with other technical indicators to create a consistent trading system that can be effective.
Interestingly, John Bollinger, the inventor of Bollinger Bands, has shown a keen interest in the crypto markets recently.
Directional Movement Index (DMI)
DMI is an indicator developed to spot price trends (consistent upward or downward movements). Similar to RSI and the stochastic oscillator, DMI is also plotted between 0 and 100. DMI has three curves:
- ADX (average directional index)
DI+ and DI- are calculated from the high, low, and close values of the past periods. ADX curve takes these values and normalizes them with an EMA. DMI lets you calculate the strength of a trend and make entry and exit at the right times. However, DMI is a lagging indicator, which means it will identify the trend only after the trend has already started.
Is Technical Analysis Always Right?
While many TA techniques are tried and tested, and often perform with a good degree of accuracy, the truth is no one can predict which way the market will move with 100% accuracy all the time. This is especially true with the cryptocurrency market, which experiences high volatility.
Likewise, it's crucially important to remember that TA is only as good as the trader performing it - some TA experts are much better at spotting wider market trends than others. If you just want to buy into a cryptocurrency for a long term return on investment, it may be better to focus on its fundamentals.
Although these technical indicators were developed with a lot of analysis and study of thousands of stocks, currencies, cryptos and their trends, volatility, and price action, they are still based on historical data and may not always give accurate predictions. It would be wise, therefore, to trade with appropriate stop-losses in place and exit at the right time, without getting carried away by emotion.
Be sure to check out our Technical Analysis section to see what our analysts think is in store for your favorite coin.