Technical Analysis Guide - Part 1: The Essentials

One thing that I absolutely love about the crypto market is the limited number of factors that can have an impact on price movements. The stock market price of an asset could be impacted by a large number of factors such as regulations, media, inflation, unemployment rate, foreign exchange rate, what the CEO of the company says and does, various announcements like stock splits and dividends, etc. These kind of factors can have unpredicted effects on the price of the security which makes the technical analysis less accurate.

In contrast, there are a limited number of factors that can influence the crypto market, which makes technical analysis far more valuable and accurate. If SEC doesn't release some news regarding possible regulations for the cryptocurrencies, if some major player from the stock market doesn't do something stupid or if Elon Musk doesn't change his bio on tweeter too often, the price of the crypto assets will move according to the technical analysis patterns most of the time.

I believe technical analysis is a must for all non-hodlers who are making daily deals on exchanges. This is the first article from a series that will provide you the information you need in order to use technical analysis to your advantage and become a better trader. Since this guide will take you from zero to hero, let's start with some basics.

Technical analysis is a means of examining and predicting price movements in the financial markets, by using historical price charts and market statistics. It is based on the idea that if a trader can identify previous market patterns, they can form a fairly accurate prediction of future price trajectories.

The theory behind the validity of technical analysis is the notion that the collective actions – buying and selling – of all the participants in the market accurately reflect all relevant information pertaining to a traded security, and therefore, continually assign a fair market value to the crypto assets. (this is related to the Efficient Market Hypothesis of E. Fama for those with financial background.)

In a nutshell, the technical analysis = using past price as an indicator of future performance.

Even though the history of technical analysis is quite intriguing, I don't want to bore you with such things so let's get straight to some important metrics of this concept.

1. Time frame

Technical traders analyze price charts to attempt to predict price movement. The two primary variables for technical analysis are the time frames considered and the particular technical indicators that a trader chooses to utilize. The technical analysis time frames shown on charts range from one-minute to monthly, or even yearly, time spans. If you change the time frames, you will see different charts with more or less noise.

Here are the time frames I recommend:

• 1 hour, 2 hours, 4 hours - for people who are trading on a daily basis (the so-called day traders);
• 1 day, 1 week, 1 month - if you are more of a holder that makes trades once or twice per week.

What I don't recommend is using the 1 min, 5 min, and 15 min time frame which is really risky and is associated with something called scaping. I know you might find some patterns that might indicate a powerful uptrend, but if you are using a timeframe of 5 min, some whales might place a high volume order against you and you would lose in the end.

2. Candlesticks

Candlestick charting is the most commonly used method of showing price movement on a chart. A candlestick is formed from the price action during a single time period for any time frame. Each candlestick on an hourly chart shows the price action for one hour, while each candlestick on a 4-hour chart shows the price action during each 4-hour time period.

Candlesticks are “drawn” / formed as follows: The highest point of a candlestick shows the highest price a crypto asset traded at during that time period, and the lowest point of the candlestick indicates the lowest price during that time. The “body” of a candlestick (the respective red or green “blocks”, or thicker parts, of each candlestick as shown in the charts above) indicates the opening and closing prices for the time period. If a blue candlestick body is formed, this indicates that the closing price (top of the candlestick body) was higher than the opening price (bottom of the candlestick body); conversely, if a red candlestick body is formed, then the opening price was higher than the closing price.

3. Candlesticks patterns

Candlestick patterns, which are formed by either a single candlestick or by a succession of two or three candlesticks, are some of the most widely used technical indicators for identifying potential market reversals or trend change.

Doji candlesticks, for example, indicate indecision in a market that may be a signal for an impending trend change or market reversal. The singular characteristic of a Doji candlestick is that the opening and closing prices are the same so that the candlestick body is a flat line. The longer the upper and/or lower “shadows”, or “tails”, on a Doji candlestick – the part of the candlestick that indicates the low-to-high range for the time period – the stronger the indication of market indecision and potential reversal.

The typical Doji is the long-legged Doji, where price extends about equally in each direction, opening and closing in the middle of the price range for the time period. The appearance of the candlestick gives a clear visual indication of indecision in the market. When a Dogi like this appears after an extended uptrend or downtrend in a market, it is commonly interpreted as signaling a possible market reversal, a trend change to the opposite direction.

The dragonfly Doji, when appearing after a prolonged downtrend, signals a possible upcoming reversal to the upside. Examination of the price action indicated by the dragonfly Doji explains its logical interpretation. The dragonfly shows sellers pushing price substantially lower (the long lower tail), but at the end of the period, the price recovers to close at its highest point. The candlestick essentially indicates a rejection of the extended push to the downside.

The gravestone Doji’s name clearly hints that it represents bad news for buyers. The opposite of the dragonfly formation, the gravestone Doji indicates a strong rejection of an attempt to push market prices higher and thereby suggests a potential downside reversal may follow.

The rare, four price Doji, where the market opens, closes, and in-between conducts all buying and selling at the exact same price throughout the time period, is the epitome of indecision, a market that shows no inclination to go anywhere in particular.

Technical analysis, done well, can certainly improve your profitability as a trader. However, what may do more to improve your fortunes in trading is spending more time and effort thinking about how best to handle things if the market turns against you, rather than just fantasizing about how you’re going to spend your millions.

So that's it for Part 1 of the guide. In the next article, I will present to you some technical indicators and some more patterns that you can use in your trading.

Good luck and remember to trade responsibly!