Technical analysis is a trading technique that uses historical price and volume data to forecast the future price of assets such as stocks, commodities, and currency pairings. It can be applied to any market including the cryptocurrency so one can trade crypto and discover new investment opportunities.
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 security.
Technical traders believe that current or past price action in the market is the most reliable indicator of future price action.
Technical analysis is not only used by technical traders. Many fundamental traders use fundamental analysis to determine whether to buy into a market, but having made that decision, then use technical analysis to pinpoint good, low-risk buy entry price levels.
The most important thing for a technical analysis trader to see is historical market data. This is done by using a trading chart. A trading chart displays a variety of information. Most commonly market prices, volume, and technical indicators.
Here are some of the most common trading charts:
The most basic chart is the line chart. This simply displays closing prices over time as a continuous solid line.
This is the most common chart used by traders. Unlike line charts, who generally return a series of closing prices, candlestick charts return as series of candles that allows the trader to access both the opening price, high price, low price, and closing price.
The area between the closing price and opening price is referred as the body of the candle, while the thin lines connecting the high/low price are called wicks or shadows.
When the closing price is higher than the opening price, the candle is said to be bullish, while a bearish candle occurs when the closing price lower than the opening price.
Heikin-Ashi candlesticks are a smoother variant of traditional candlesticks, removing confusing variations from the price, thus making it easier to analyze.
Keep in mind that heikin-ashi candles do not display true market prices values, you should not backtest any strategy using heikin-ashi as the results would be unrealistic. For more information click here.
Trading volume shows the number of traded shares in a certain period of time, and as such quantify the amount of trading activity and liquidity. Volume is considered for some traders to be one of the most important information available.
On Tradingview, volume can be applied to a chart from the indicator panel.
Trends show the general direction price is taking over a significant period of time. Historical prices are composed of a series of different trends, with some increasing, decreasing, or being stable.
Underlying trends in the price are contaminated with other variations such as periodic and irregular variations, these parasitic variations are major problems when it comes to successfully trade a trend.
Trends are classified based on their main direction.
An uptrend is characterized by the price sloping upward, making regular new higher highs and higher lows.
A downtrend is characterized by the price sloping downward, making regular new lower lows and lower highs.
A sideways trend is characterized by the market not moving in a particular direction, the price is not making new higher highs or lower lows, but instead, fluctuates within a specific range.
In a sideways trend, we often say that the market is ranging, consolidating, or less commonly trend stationary.
Trends can have many forms, they can be linear or non-linear and can contain retracements, which are variations that have a direction opposite to the main trend. Retracements are caused by cyclical variations in the price and can affect the performances of a trend trading strategy.
Reversals are defined as changes in the direction of a trend. While a lot of traders confirm the presence and direction of a trend in the price to enter a position, others try to spot reversals, the benefits include potentially higher profits, however, spotting reversals is a complicated task.
Technical analysis supports the idea that the longer it takes for a reversal to occur, the greater will be the price change that follows.
The support and resistance methodology is one of the oldest and most well known in technical analysis. Support and resistances consist of lines where the price regularly bounce, when the price reaches a resistance, it bounces back toward the support, and when it reaches the support, it bounces back toward the resistance.
Support and resistances can be manually drawn or be determined by a technical indicator. In case they are manually drawn, it is common to connect a recent swing high/low with a past swing high/low and see if the resistance/support was significant.
When the price cross under a support, or cross over a resistance, we say that price broke its support/resistance, this often suggest the start of a strong trend, with an up-trend occurring when the price breaks its resistance, and a strong down-trend occurring when the price breaks its support.
Sometimes an old support can become a new resistance, and vice versa, when this occurs we say that there has been a change in polarity.
Technical indicators are represented by a series of observations derived from one or various mathematical calculations processing historical market prices and/or historical volume. Some indicators can be described as rolling statistics processing data over a finite window length.
The interpretation of technical indicators allows the trader to perform a certain action such as entering or closing a certain position.
Depending on their behaviors, technical indicators can be classified into two main categories, leading indicators, and lagging indicators.
Leading indicators, as their name suggests, can anticipate market price variations, they have more predictive power than lagging indicators. While this would suggest that leading indicators are the perfect indicators to use, it must be noted that they do not fully reflect future price variations, and can therefore lead to losing trades.
Lagging indicators on the other hand return delayed information to the user, they reflect what has happened and therefore hold less predictive power than leading indicators, this is why leading indicators are instead used to confirm a price movement such as a new trend. While lagging indicators fully reflect past price variations they suffer from the delay (lag) they produce.
The type of a technical indicator is determined by the information the indicator processes and return. There are 4 main types of technical indicators each one listed below: