Every trade and investment is decided after conducting meticulous research and scraping market data off the internet. Without examining potential futures and asset prospects, one may as well be trading blindly, which is common among beginners.
A real professional trades only after spending hours and hours identifying the latest trading opportunities. The means of such research stems from technical analysis.
Technical analysis, commonly abbreviated as TA, is the art of evaluating investments by analyzing technical market data. This includes price actions, trading activity, trading volume, order book comparisons, patterns, candles, and so on.
Note that this is a stark contrast to fundamental analysis (FA), a different type of analysis that focuses on determining an asset’s real value by inspecting teams, tokenomics, smart contracts, etc.
Day traders who focus on short-term trades often use TA in combination with charting software to analyze possible price movement for a cryptocurrency. One can draw on a chart (e.g., trendlines and channels) or use existing indicators to predict which direction a crypto-asset might take.
Historical market data is the basis of every TA journey. It is generally believed that one can anticipate an asset’s price by looking at how the price behaved historically under similar circumstances. On that account, TA can be seen as the art of understanding and identifying patterns - which are bound to repeat as a result of market psychology.
How to use Technical Analysis
As previously mentioned, we can use any type of technical market data when conducting technical analysis. For example, one may take a stroll at an exchange’s order book section to look for discrepancies between bids and asks, identify common candle patterns on charts, or use a diverse set of indicators.
Commonly used TA indicators include:
RSI (relative strength index)
Moving averages (MA) cut down noise in the market and prove clarity by representing lagging trends. MAs use data from a set period of time and produce an average price for the selected price period, indicating the direction of an asset. Traders commonly utilize simple moving averages (SMA), but lately, exponential moving averages (EMA) have been popularized.
Bollinger bands are an oscillator-type indicator that reveals whether an asset is overbought or oversold. These bands move around a moving average line and additionally provide the trader with information in regards to volatility.
RSI is the number one indicator used by traders of all skill levels. RSI is another oscillator-type indicator that uses a mathematical formula to calculate whether an asset is overbought or oversold. The oscillator ranges from 0 to 100, and if RSI reaches a level beyond 70, the asset is overbought. If the asset is below 30 RSI, we consider it to be oversold. While in the middle of the range, the asset is neutral and shows no clear bull/bear signs.
Ichimoku clouds are a more complex indicator generally implemented by experienced traders. IC introduces new lines to the chart, which are calculated based on historical price data. The lines represent support and resistance levels as well as trend direction and momentum. Moreover, the clouds themselves are used for directional trading as they indicate whether an asset is currently in a bearish or bullish phase.
There are, of course, many indicators to choose from. Beginners who are still new to technical analysis are advised to begin with candle patterns before venturing into indicators - especially complex indicators such as Ichimoku clouds.
Advantages and disadvantages
At the end of the day, technical analysis is simply a tool used to predict future market events. Although TA largely depends on historical market data and the possibility for events to replay in a similar fashion, the truth is that not all TA is correct.
Market psychology plays a key part in market activities. In this case, TA is deemed to be a self-fulfilling prophecy as a majority of investors create their decisions by relying on TA. If enough market participants use the same tactics, an asset is bound to perform in the way described by the aforementioned analysis.
Nevertheless, technical analysis indeed provides an efficient method of predicting the future. While external or unexpected events may drive assets in a different direction, assets often play out favorably for TA experts. We also have to keep in mind that even alternative methods like fundamental analysis are inherently subjective and that there is no better system for anticipating market activity.