What is Technical Analysis

The market trend for digital currencies follows the one in the traditional financial market closely. Both react according to the market’s supply, demand, and macro and microenvironmental influences. Each encrypted asset is equivalent to stock in the traditional financial market. They have their respective characteristics and supporting values. Therefore, investors can form a more accurate forecast of market conditions by assessing market trends, news, and fundamental and technical analysis based on available data.

This article will briefly describe the basic concepts, characteristics, and usage of technical analysis.

What is technical analysis?

The two core concepts in technical analysis are: 1) Market behavior includes all information, and 2) Financial history will repeat itself. 

Technical analysis uses the law of supply and demand to establish a set of financial market analysis methods. They are used for analyzing market trends and predicting future market trends. In the field of cryptocurrency, the technical analysis includes analysis of various indicators (Candlestick patterns, trend analysis, volume-price analysis, divergence, etc.). Investors can infer market conditions based on historical prices and trading volumes. The results from such inferences are used to determine the best buying/selling point. It is one of the most commonly used and effective market analysis methods in the field of cryptocurrency trading.

Furthermore, quantitative strategies are established based on technical analysis, making it the foundation for quantitative trading.

Pros and Cons of technical analysis

Pros: Technical analysis allows us to have an overall sentiment of the supply and demand in the market. Since the market is a game of buying and selling, market sentiment is shaped by the two opposing forces. Mastering and using the patterns allow investors to react to the market shifts promptly.

Cons: Technical analysis requires the accumulation of professional knowledge and investment experience, and it is difficult for beginners to master. In cryptocurrency, non-mainstream currencies cannot form reliable and effective technical analysis results due to their market capitalization, volume, and liquidity. Therefore, the more niche currencies are, the less suitable technical analysis is for analysis.

Examples of technical analysis indicators

Technical analysis involves multiple indicators and each of them corresponds to different market sentiment. Through the indicators, it is possible to determine whether the market has room for continued rise or fall.

  1. Support and Resistance

A support level is the lowest price level within a cyclical period and is typically formed when the lowest price level cannot be broken downwards. The underlying principle of support level is that during this period, the sellers are collectively optimistic about the long-term market environment. When there is a high demand, it is unlikely that the price will fall below the support level. It is because the market supply is not enough for the price to be tested at a lower level.

The breaking down of the support level can be observed when volume decreases and the price consolidates, which can be represented by the long upper shadow, inverted hammer, and gravestone Doji.

The resistance level (pressure level) indicates that the price reaches the top within a cyclical period, and the price has been unable to break upwards. The underlying principle of pressure level is that the sellers continue to supply at this price level and buyers do not have enough buying power to push the price above resistance. 

The breaking up of the resistance level can be observed when volume decreases and the price consolidates, which can be represented by the dragonfly doji, hammer, and long lower shadow.

  1. Moving Average (MA)

A moving average is a statistical analysis method that shows the average asset price over a certain period in a linear fashion. There are three types of moving averages that are most commonly used in technical analysis in the cryptocurrency field, the 5-day moving average (MA5), the 10-day moving average (MA10), and the 30-day moving average (MA30). In MEXC’s trading platform, it is represented by three thin lines in red, yellow, and blue in the candlestick chart.

A. Follow trends

The moving average is consistent with the trend in the candlestick patterns, which can eliminate the “noise” caused by randomness in the market. Moving average allows investors to accurately and objectively see the cyclical trend. The trend and crossover of the three moving averages can be used as signals.

In the above picture, BTC has dropped to 39602, but the moving average has little to no fluctuations. The price closes above the moving averages, indicating holding costs are higher than all the MAs. When the price is 39602, the market will inevitably adjust itself, resulting in a reversion to the mean.

B. Lagging indicator

The changes in the moving average are relatively slow and often lag behind the change in currency price. Therefore, market expectations derived from moving averages are generally more applicable for longer investment horizons.

Technical analysis also includes commonly used indicators such as Bollinger Bands (BOLL), Parabolic Stop and Reverse (SAR), and Exponential Moving Average (EMA). When you are more familiar with these basic indicators, you can proceed with the relative strength indicator (RSI), DMI trend indicator, and On-Balance-Volume (OBV) for technical analysis of the market.

Closing thoughts

Technical analysis is based on the concepts of “market behavior includes all information”, and “financial history will repeat itself”. The formation of market patterns in a period applies to other periods. An experienced trader can obtain huge returns by seizing opportunities using technical analysis – which explains why it is also one of the most popular analysis methods for investors in the market.

Market trends are the results of human activity, and it is impossible for any technical analysis method to completely cover every single aspect. Therefore, technical analysis cannot be applied to every single market condition. When investing, only the history is certain.

Disclaimer: Trading crypto involves significant risk and can result in the loss of your invested capital. The materials are not related to the provision of advice regarding investment, tax, legal, financial, accounting, consulting, or any other related services and are not recommendations to buy, sell, or hold any asset. MEXC Learn solely provides information, but not financial advice. You should ensure that you fully understand the risk involved before investing.

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