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An Introduction to Technical Analysis: Part I

Part I of our TA tutorial for crypto traders


75 posts


2022/03/01 03:36:22

1. Preface
2. What is technical analysis?
3. Types of charts
4. Support and resistance levels
4.1 Trend Lines
4.2 Trend Channels
4.3 Different techniques to trade using support and resistance
5. Conclusion Part I

1. Preface

In our previous tutorial, we covered the basics of fundamental analysis. TLDR: fundamental analysis tells (crypto) investors which coin or token to invest in using different metrics to estimate the real value of a project. The next step is to determine when to invest in the project. That is why we’ve written this tutorial about technical analysis. You've probably heard of this type of analysis a million times already. It’s used very often in the crypto scene by influencers. In case you wish to learn how to do this kind of analysis yourself, keep reading!

2. What is technical analysis?

Technical analysts look at past price movements as trustworthy indicators of current market conditions and future price movement. They look for price levels (historical price support or resistance levels) and chart patterns. If a certain price held as a major support level it could be the right time to buy. Conversely, If a certain price is held as a resistance level, it could be time to sell or to go short. They identify these price levels and patterns by using charts.

So, how useful is technical analysis? If you admit to believing in TA, people who support the efficient market hypothesis will laugh you out of the room. They believe technical analysis (and fundamental analysis, for that matter) is useless in investing because the conclusions are already priced in. It makes no difference to them when you buy or sell a crypto coin/token. You will always pay or receive the price that is based on its current market value. However, one can question the extent to which crypto markets are indeed efficient. Furthermore, many have pointed out that markets aren't all that rational. Human emotion (are you bullish or bearish) also plays a significant role in investment decisions, and people can have different emotions based on the same available market information. When traders and investors are emotional, they are more likely to make cognitive mistakes and rely on heuristics or shortcuts. We'll go over Sentiment Analysis in more detail later.

The truth is that if enough traders look at the same charts and act on the same patterns, a self-fulfilling prophecy may emerge. Technical analysis is used by many cryptocurrency traders. Another catalyst of the adoption of this type of analysis is that the most powerful crypto influencers are frequently technical analysts who share their knowledge with their large followings. Crypto-related news publishers also report on daily price movements. In other words, even cryptocurrency traders who do not use technical analysis may base their decisions on those of influential individuals and channels who do.

It’s important to note that you cannot use technical analysis to predict the future direction of price. Rather, you can use it as a tool to determine the probability of different outcomes. If A occurs, it is very likely that B will follow. If this hypothesis is rejected, you can create a new one and base your investment decisions on it. To that extent, one could argue that technical analysis is indeed quite helpful.

3. Types of charts

A price chart is simply a visual representation of the price of a currency pair over a specified time period. Charts are used by technical analysts because they make it visually easy to identify and analyse the movements, patterns, and tendencies of a currency pair.

There are three popular types:
1. A line chart
2. A bar chart
3. A candlestick chart

Line chart
A simple line chart draws a straight line from one closing price to the next. Price fluctuations within a trading session are ignored by focusing solely on the close. This makes identifying trends easier. Furthermore, some traders believe that the closing level is more important than the open, high, or low. As a result, this type of chart is frequently used to obtain a "big picture" view of price movements. However, the line chart may not provide the trader with a lot of information about price behaviour during the period.

Fig 1: Line chart

Bar chart
Bar charts (also known as "OHLC" charts) visually represent the open, high, low, and close prices of a coin or token over a given time period. The vertical line on a price bar represents the period's high and low prices. The open and closing prices are represented by the left and right horizontal lines on each price bar.

Fig 2: Bar chart

The opening price is indicated by the small horizontal line on the left.
High: The highest price of the time period is defined by the top of the vertical line.
Low: The bottom of the vertical line represents the time period's lowest price.
The closing price is indicated by the small horizontal line on the right.

Candlestick chart
The candlestick chart is a type of bar chart, but many traders prefer it because it is easier to read. The price range between the opening and closing prices is represented by the larger block (or body) in the middle of a candlestick chart. Candlesticks help to visualize bullish or bearish sentiment by displaying "bodies" in different colors.
If the middle block is red, it means that the currency pair closed LOWER than it opened. The opening price of the block is at the top, and the closing price is at the bottom. The middle block will be green if the closing price is higher than the opening price.

Fig 3: Candlestick chart

Candlesticks have numerous advantages. While a line chart only provides one data point (the close price) for a coin or token at any given time, candlestick charts provide five: open, close, low, high, and direction of movement. When your trading decisions are solely based on price action, this is a significant advantage.

4. Support and resistance

Technical analysis is all about finding levels of support and resistance. Traders trade on these price levels that operate as barriers, stopping an asset's price from moving in a particular direction.
Support: a price level a coin/token has reached after a drop. At this price level, a drop can be expected to stall (increase of buy limit orders) and potentially reverse (buy market maker orders) due to increased demand.
Resistance: The opposite of support. At this price level, there is a lot of selling pressure on the price of a currency or token, which prevents it from going up any further and may even cause it to reverse.

Fig 4: Support and resistance

Once discovered, support and resistance levels can be used as potential entry and exit locations. Price will either bounce off a support or resistance level. Support and resistance levels become stronger the more times they are tested. Alternatively, the price can break through one of these levels, which is referred to as a breakout. If price changes stop at the support or resistance level, traders can instantly see if their predictions were correct. If the level breaks, the position can be closed at a small loss. However, if the price moves in the right direction potential gains can be significant.

Fig 5: Resistance level breakout followed by new levels of resistance and support.

In figure 5, you see that a previous resistance has become a new support. It also works the other way around, where a previous support becomes a new resistance. So why is that? It’s mostly because people who anticipated a bounce and are losing money because it broke instead will try to exit their trade when price pulls back again near the price of entry. Keep in mind though that price doesn’t always retrace. As such, always make use of stop loss orders and don’t hold onto bad trades.

False Breakouts
False breakouts occur when the price goes back above/below the support/resistance it just broke through. Buying or selling activity was insufficient to maintain the breakout in the case of a false breakout. They occur often and can get traders to regret their trades.

Fig 6: False breakout: support was broken, but only temporarily. Source: Babypips

So, how do you recognize a false breakout? If the price is rapidly rising, see if it breaks out of the previous high. Exit your trade if the move up comes to a halt near the top of the previous high. For a drop in price, do the opposite. The method is simple but it requires patience.

4.1 Trend Lines

A trend line is a straight line that connects two or more price points and then extends into the future to act as a support or resistance line. Many of the aforementioned principles that apply to support and resistance levels also apply to trend lines.

Uptrend line (higher lows)
An uptrend line is formed by connecting two or more low points with a positive slope. For the line to have a positive slope, the second low must be greater than the first.
Uptrend lines serve as support and indicate that net-demand (demand minus supply) is increasing even as prices rise. A rising price combined with rising demand is extremely bullish and demonstrates the buyers' determination. The uptrend is considered strong and intact as long as prices remain above the trend line. A break below the uptrend line indicates that net demand has weakened and that a trend reversal (decrease in price) may be on the way.

Fig 7: Uptrend line

Downtrend line (lower highs)
A downtrend line is formed by connecting two or more high points with a negative slope. For the line to have a negative slope, the second high must be less than the first.
Downtrend lines serve as resistance, indicating that net supply (supply less demand) is increasing even as prices fall. A falling price combined with an increase in supply is extremely bearish and demonstrates the sellers' tenacity. The downtrend is strong and intact as long as prices remain below the downtrend line. A break above the downtrend line indicates that net supply is declining and that a trend reversal (increase in price) is possible.

Fig 8: Downtrend line

Sideways trend line (ranging)
A sideways trend occurs when the price moves in a narrow band, neither upward nor downward. This usually happens during a period of consolidation before the price resumes or reverses into a new trend.

Fig 9: Sideways trend line

Trendlines key takeaways
The steeper the trend line you draw, the less reliable it will be and the more likely it will break.
Trend lines, like horizontal support and resistance levels, become stronger the more times they are tested.

Trendlines limitations
When with all charting tools, trendlines must be adjusted as new price data becomes available. A trendline can be maintained for an extended amount of time, but eventually the price movement deviates sufficiently to necessitate updating. Additionally, traders routinely integrate diverse data points. Certain traders focus exclusively on the lowest lows, while others focus exclusively on the lowest closing prices. Finally, smaller time frame trendlines can be volume sensitive. A trendline built on low volume might easily be broken as session volume increases.

4.2 Trend Channels

We create a "channel" by drawing a parallel line at the same angle as the uptrend or downtrend. The upper trend line denotes resistance, while the lower trend line denotes support. As a result, the tops and bottoms of channels can both represent potential areas of support or resistance. Trend channels with a negative slope (down) are bearish, while those with a positive slope (up) are bullish.

Fig 10: Trend channels

When prices reach the lower trend line, this could be a good time to buy. Conversely, when prices reach the upper trend line this could be a good time to sell.
A channel boundary that slopes at one angle while the corresponding channel boundary slopes at another is no longer a trend channel but a triangle. We'll go over triangles in greater detail later. However, trend channels do not have to be perfectly parallel. Furthermore, not all price action have to fit within the channel.

4.3 Different techniques to trade using support and resistance

We've talked about how to determine the levels of support and resistance. But how do you use these levels to your advantage when trading?
There are two strategies.

1. The Bounce
Trading support and resistance levels following the bounce is one strategy.
Many traders make the mistake of placing orders on support and resistance levels. First, you want to see if support and resistance levels will hold. You do this so you can avoid scenarios where the price breaks through support and resistance levels. As such, when buying coins/tokens you first want to wait for it to bounce off support. Conversely, when you go short you first want to wait for it to bounce off resistance before entering.

2. The Break
Support and resistance levels frequently break. So trading bounces isn't enough. What are the strategies to follow when support and resistance levels fail?

There are two ways to trade a break:
Aggressive strategy
Conversative strategy
The aggressive strategy entails that traders buy or sell if price convincingly goes through a support or resistance zone. The conservative strategy means that rather than entering immediately after the break, you wait for the price to "pullback" to the broken support or resistance level. You then enter after the price bounces.

5. Conclusion Part I

In Part I of the CoinScouts Technical Analysis Tutorial, we discussed the significance of charts and explained various indicators of support and resistance. We also explained the different trading strategies built around these price levels. In our next tutorial, we'll look at more support and resistance indicators, such as fibonacci, moving averages, and round numbers. We'll also go over some of the most popular chart indicators.

Stay tuned for Part II

Useful links


51 posts


2022/11/28 11:32:51

Nice Education

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