As we rightly stated in the previous article, Technical analysis is a method of evaluating a financial asset by analysing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead, use charts and other tools to identify patterns that can suggest future activity. What we will aim to achieve is to discuss the general tools used by technical analysts.
What separates technical analysts’ from their fundamental counterparts?
Technical analysts’ exclusively use:
- Historical prices: these are past prices of an instrument (open, high, low and close).
- Volume data: A cryptocurrency exchange usually shows it’s own volume for each crypto pair (such as ETH/NGN), that is the amount traded on that particular exchange, normally in the last 24 hour.
- Exotic tools and indicators are items that enhance the analysis of cryptocurrencies. These exotic tools are, but not limited to, Lines(horizontal, vertical and trend lines), Moving averages, Various oscillators(eg. Stochastic Oscillator), etc.
Strategy toolbox (basic) for a technical analyst
- Price (most suitable if viewed as candlestick): A value that will purchase a finite quantity, weight, or other measures of a digital asset.
- Support and Resistance zones: Support level/zone refers to the price level below which, historically, a financial asset has had difficulty falling. Resistance level is a price point on a chart for an asset in which upward price movement is impeded by an overwhelming level of supply for the asset that accumulates at a particular price level.
- Technical Indicators: Technical indicators look to predict the future price levels, or simply the general (e.g Relative Strength Index, Stochastic Oscillator, etc)
As stated above, price is the value that will purchase a finite quantity, weight, or other measures of a digital asset. Technical analyst believe that all relevant information about a financial asset is already present in the price. Another topic that arises when talking about price is price action. Price action as stated by Investopedia is a technique by which a trader reads the market and then makes a decision based on the actual price movement on the chart, rather than relying on lagging indicators. Most indicators are measured based on prices on the chart, meaning that they may be unnecessary and are reflective of past information.
Support level/zone refers to the price level which, historically, a financial asset does not fall below. It is the level at which buyers tend to enter the stock. They may be very short-lived or may remain a support level over an extended period of time.
If the price of a cryptocurrency falls toward a support level, it is a test for the asset: the support is either confirmed or eradicated. Confirmation occurs as buyers move into the asset, causing it to rise. If the price moves past the support level, it means the support level failed, and the market is looking for a new level. See example below.
As seen in the graph above, the price touched the 120 USD level and pushed back up. This level acted as a support as the price pushed towards that level, but couldn’t go below the level and then started retracing back upwards. Similarly, the price dropped to the 103 USD level and pushed back upwards. This level then acted as a support again as the price fell back to that same level and started moving back upwards.
Resistance level is a price point on a chart for a financial asset in which upward price movement is impeded by an overwhelming level of supply for the asset that accumulates at a particular price level.
Resistance levels are characteristically found at the upper levels of range bound markets. They may also be very short-lived or may remain a resistance level over an extended period of time. Let’s take a look at an example.
Technical indicators look to predict the future price levels, or simply the general price direction, of a financial asset by looking at past patterns. Below are a couple of common technical indicators, I will be breaking down the first two:
- Moving Averages
- Relative Strength Index
- Money Flow Index
- Bollinger Bands
Moving averages are widely used indicators in technical analysis that helps smooth out price action by filtering out the “noise” from random price fluctuations. A moving average (MA) is a trend-following or lagging indicator because it is based on past prices.
The two basic and commonly used MAs are:
- Simple Moving Average (SMA) which is the simple average of a security over a defined number of time periods.
- Exponential Moving Average (EMA) which gives a bigger weight to more recent prices.
Importance of the moving average
- It helps to easily identify a trend
- Act as a resistance and support level
Relative Strength Index
The Relative Strength Index (RSI) is a momentum indicator that tries to compare the magnitude of recent gains and losses over a defined time period to measure speed and change of price movements of a security.
- To identify overbought or,
- To identify oversold regions in an asset.
Traditional interpretation and usage of the RSI are that RSI values of 70 or above indicate that a security is becoming overbought or overvalued, and therefore may be primed for a trend reversal or corrective pullback in price. On the other side of RSI values, an RSI reading of 30 or below is commonly interpreted as indicating an oversold or undervalued condition that may signal a trend change or corrective price reversal to the upside.
As seen in the graph above, as the RSI line dropped below the 30 level and pushed back above the line, the price moved higher. Inversely, as the RSI line rose above the 70 level and broke below the line, the price dropped lower.
In summary, here are four takeaways for technical analysis:
- Keep it simple
- The most important is the price, support and resistance levels
- Understand the basic and most important technical tools
- Indicators are powerful but are secondary tools