The Dark Art Of Cryptocurrency Technical Analysis
Technical analysis is the second primary used to analyze a coin to determine it’s investment value and security. This form of analysis involves examining the past market data, primarily the price and the volume of a coin, and using these market indicators to statistically quantify the future value of a cryptocurrency. Despite, the cryptocurrency market being highly volatile, technical analysis demonstrates that there is some logic to trading in this currency and the market can be forecasted with a reasonable degree of precision.
There is a range of market indicators which can be used to forecast the value of a coin. However, not all of them are reliable or provide useful information. Below are the most accurate and trustworthy market indicators which every smart crypto trader should use. If you want to learn everything you need to start trading cryptocurrency head to the Blockcircle trading academy and get started for free.
The moving average of a coin is one of the simplest and most powerful market indicators which can be used to forecast the future value of a coin. The average value of a coin is represented by its closing price and therefore, an average value can be calculated by examining this price over a certain period of time. For identifying short term trends, a simple moving average can be used which considers that average of a coin’s closing prices over a period of 50 day or 25 day days. As the new data becomes available, old data is dropped and this causes the average to move along the time scale.
These short term fluctuations can be short-lived and therefore, to confirm a trend, it is important to compare them to the long term moving averages called exponential moving averages. These average can be calculated by looking at the closing prices of a coin over a 100 day or 200 day period. The exponential moving average applies more weighting to recent prices however takes into consideration the closing price of the coin all days prior to the current day.
When comparing the two moving averages, if the short term moving average drops below the long term moving average, this indicates that the market is falling. Consequently, the opposite is true, if the short term moving average grow above the long term moving average, then this indicates that the market is picking up.
Moving average convergence/ divergence
Moving average convergence/ divergence (MACD) indicates market dynamics and can be used to predict a trend and its strength before it even begins. The MACD is the difference between a longer moving average and a shorter moving average and is represented as a line plotted on a MACD histogram. Generally, this line is calculated by subtracting the 12 days EMA from the 26 EMA. Then a 9-day EMA of the MACD line is plotted as a Signal Line on the graph.
The Moving average convergence/ divergence can help guide investors decisions around buying or selling a particular coin. When the MACD line touches the signal line, this signals to change market trends. Additionally, if the MACD drops below the signal line, this is an indication that you should sell your cryptocurrency and if the opposite occurs it is advisable to further invest in the coin.
Market depth refers to the ability of a coin to withstand fluctuations in demand without this significantly affecting the price and tells the size of an investment needed to move the market price by a certain amount. This indicator tells the volume of cryptocurrency available for purchase and sale, with the lowest point on the graph indicating the current value of a coin. If the market is deep then a large order is needed to change the price and thus the price of the cryptocurrency is quite stable.
Most recent trades
This indicator involves examining the latest trade made on a platform. This will be displayed on almost all crypto trading platforms and allows you to study the trades made by the most profiting traders. Examining recent trades allows you to understand the prices at which the coin is being purchased or sold. It also allows you to determine the mood of the community which is important as the crypto market is largely determined by investors and traders. If the community determines that the market is going up, then there will be a high incidence of buying and the price of the coin will increase and vice versa. If a significant number of people are making the same move then it is wise to replicate their purchases or trades.
In addition to examining recent trades, the trading volume of coins can be used to indicate the mood of the community towards a specific coin or a change in price. Trading volume is commonly represented as a bar graph and indicates the volume of trades that occur at various times. If the price of a coin increases and the trading volume also increases, this is an indication that the market supports this change in price. In contrast, if volume decreases with a change in price, then the market is against this price rise. This is important to understand as a lack of support for a price change can indicate that price change will be a short term trend that will soon end.
Accumulation/ distribution indicator:
The accumulation/ distribution indicator aims to gauge the supply and demand of a coin by ascertaining whether cryptocurrency investors are generally accumulating (buying) or distributing (selling) a coin. This is calculated by analyzing the divergences between a coin’s price and volume flow by multiplying the money flow multiplier by the volume. The money flow multiplier is the difference between the closing price and the low price of the range minus the difference between the high price of the range and the closing price. This value is then divided by the difference between the low price and the high price of the range.
Secondly, the money flow volume is calculated by multiplying the money flow multiplier by the volume of the coin for that period. Then the accumulation/ distribution line is calculated by adding the previous period’s money flow volume by the current period’s money flow volume.
The accumulation/ distribution line developed can be used to determine if a coin is trending. If the coin is in a strong downwards or upwards trend it is likely that the accumulation/ distribution line will follow. If the coin’s price is in an upward trend and the accumulation/ distribution line is in a downward trend, this suggests that there may be selling pressure and that this may cause the price to reverse and turn downwards. Additionally, the reverse is true. This indicator is useful to determine divergence when the accumulation/distribution line is heading in the opposite direction as the price line. This will indicate a reversal in trends and will help steer your investment and trading decisions.
Relative strength index
The relative strength index (RSI) is a momentum indicator which is used to identify the speed of price movements. An RSI can only be used when a trend has already been clearly established as it is used to determine when there will be a short-term reversal in a trend. An RSI is calculated by comparing a coin’s price over time with the coin’s volume. To calculate RSI, the current closing price of a coin is compared to previous closing prices and is generally represented as a line below a price chart that rises or falls as momentum changes.
A momentary change in the trend of a coin which is knowns as divergence is indicated when the RSI is going one way while the price is going the other. During bearish divergence, when the RSI is starting to decrease while the price is still rising, this is an indication that the momentum of the coin is decreasing and is a strong signal to sell the coin if the indicator reads ‘oversold’. In contrast, in bullish divergence, where the RSI is increasing while the price is decreasing, this is a sign to buy into the coin if the indicator reads ‘overbought’.
Double bottom reversal pattern
The double bottom reversal pattern is a common reversal indicator which points to where there will be a reversal from a downtrend in price to an uptrend. In order to determine if a double bottom reversal pattern has occurred the following criteria must be met.
- Prior Trend- There must be a prior downward trend in the price of the coin before the double bottom pattern occurs
- First Bottom- The price of the coin when it breaks its downward trend and spikes upwards.
- Peak- The peak is the highest price the cryptocurrency reaches after the break in a downward price trend. This high price should occur at a 10 to 20% increase from the first bottom. From here, the second bottom price should occur. This bottom price does not have to be exactly the same as the first but should occur within 3 to 4% of the first bottom. Then the line should follow an upward trend thereafter.
Once it has been established that a double bottom reversal pattern has occurred, trading should only occur after the price has risen past the peak price. It is advisable that investors buy after this point.
Double top reversal pattern
In contrast to the double bottom reversal pattern, the double top reversal pattern indicates that there will be a reversal from an uptrend in the price to a downtrend. To qualify as a double top trend, a set of criteria must be met.
- Prior Trend- There must be a prior upwards trend that occurs before the double top pattern occurs
- First Peak- This is the maximum top price the coin reaches before the downward trend begins
- Trough- The trough is the lowest price point that the coin reaches after the first peak. This drop should not be as low as the lowest point preceding it.
- Second Peak- The second peak must occur at approximately the same spot as the first peak by 1 to 3%. This is the highest point reached before the downward trend occurs and the price begins to decrease.
- Break in the Neckline- The neckline is the level or price at which the trough occurred. Once the price goes below this level, the pattern is complete and a double top has occurred.
Identifying a double top is important because when you have identified the reversal in the upward trend, it is an indication that it would be a good time to sell the coin.
Average true range (ATR)
The average true range indicators the degree of price volatility for a coin. The average true range is a moving average of approximately 14 days of true ranges.
The true range can be calculated by determining the greatest of the following:
- Method 1: Current high minus the current low
- Used when If the current period’s high is above the previous period’s high and the low is below the previous period’s low, then the current period’s high-low range will be used as the true range
- Method 2: Current high less the previous close value
- Used when the previous close is greater than the current high
- Method 3: Current low less the previous close value
- Use when the previous close is lower than the current low
The average true range reflects the degree of interest or disinterest in a move. Strong moves are often accompanied by large true ranges whereas weak moves have narrower ranges. Consequently, an upward-moving trend, with an increase in ATR, indicates a strong buying pressure and reinforces the reversal in the pattern. Additionally, a downwards moving trend with an increase in ATR supports the reversal in the trend and shows strong selling pressure
Elliott wave theory
The Elliott wave theory was developed based on the premise that the cryptocurrency market has repetitive patterns that are cyclical, due to investors’ reactions to outside influences. The uptrends and downtrends within the market were identified to often occur in the same repetitive patterns which were called ‘waves’ which could be used as predictive indicators of future market moves and trends.
Types of waves
There are two types of waves identified in this theory.
- Impulsive Waves- These are groups of three or five waves of the same pattern. This trend indicates the main direction of prices for a coin. Then three corrective waves will occur which move against the price trend.
- Corrective waves- These waves are characterized by three distinct price movements, two against the current trend and one which follows this trend.
This ability to study market trends using the Elliott wave theory, allows investors to identify where the current price is situated within the current wave cycle and thereby forecast price direction and magnitude of the next wave in the cycle.
The Ichimoku cloud indicates trends within a cryptocurrency market. It identifies the support or resistance of a trend, the direction of a trend, the momentum of said trend and provides a trading signal. If the price of a coin is above the cloud, this is an indication that the coin is currently in an upward trend. Conversely, if the prices are below, it is a downward trend. When the prices are in the cloud, this indicates a NO trade zone. This is because when the price is in the cloud, no trend can be determined and therefore there is no clear direction of the prices. Cloud breakouts are when the price lifts out of or below the cloud and this is considered to be an entry signal for investors, especially when this is paired with volume. If the price rises above the cloud investors should be looking for long term investments and if it breaks below the cloud short term investments should be considered.
Through using a combination of technical and fundamental analysis indicators, traders can make more informed decisions regarding trading and investing particular cryptocurrencies.