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What is it and how does technical analysis apply to a cryptocurrency like bitcoin?

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1 What is technical analysis (TA)?

This methodology, which studies market behavior at a historical level, enables the determination of trends in an asset. It is a widely used tool in the cryptocurrency ecosystem and can become a great ally for traders who want to take advantage of market movements.

Technical analysis is based on the belief that historical information can provide useful data to predict what will happen to the market. and upcoming market trends. Buy and sell volumes can also provide information for technical analysis.

Unlike other disciplines, such as fundamental analysisTA focuses exclusively on the study of prices. Therefore, investors who perform it use market charts and tools such as indicators to monitor all financial trading. It is a practice that examines fluctuations in the value of an asset and tries to identify the best trading opportunities.

Technical analysis is a trader’s ally

It facilitates decision making and risk management in trading. It helps to understand price changes and identify future fluctuations. For this reason, it is a widely used methodology in the cryptocurrency ecosystem to determine the most appropriate time to open or close positions.

2 What is the purpose of TA in the cryptocurrency market?

Although cryptocurrencies are highly volatile financial instruments, they have identifiable market cycles and repetitive trends that allow us to identify trading opportunities. Therein lies the role of technical analysis, which focuses on market behavior and not external factors.

This methodology is used to make short-, medium-, and long-term investment decisions. By predicting the future behavior of an asset, investors can generate strategies that match their return expectations. It also helps manage possible risk situations that may occur in an investment, such as a sharp drop in prices due to the bursting of a financial bubble.

graph of the price of bitcoin between 2020 and 2022
Price charts can provide traders with indications of a trend forming in the market. Source: TradingView.

For example, the adoption of bitcoin as a form of payment by a well-known company is an event that has positively affected the price of the cryptocurrency on several occasions. In contrast, if a regulation affects the free exchange of the currency, this could be an event that has a negative impact on its value. Such behaviors can be identified and compared through technical analysis.

3 How do you do technical analysis for a market like bitcoin?

To understand how technical analysis works, one must keep in mind that this methodology is basically the study of the current and previous price of a cryptocurrency. All financial data is fundamental information to provide answers about the behavior of a specific market.

Practitioners of technical analysis must analyze both the demand and supply of the asset they intend to trade. There are also tools that help identify the prevailing market sentiment, whether it is fear or greed among traders. Tools such as indicators, which help identify existing trends and can provide information about possible future behavior, are used to examine prices.

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For TA, no price fluctuation is random. It is assumed that these value movements can evolve into identifiable trends over time. This forms three principles of technical analysis that allow us to understand how the behavior of a financial asset is formed and predicted.

The origin of technical analysis

These premises summarize the research and theories of two American economists: Ralph Nelson Elliott, creator of wave theory, and Charles Henry Dow, also a journalist and the father of the so-called Dow theory. Both are forerunners of technical analysis.

4 The principles of technical analysis

“Price discounts everything” is the first principle of TA. This phrase refers to the fact that all elements that have influenced or may influence the valuation of an asset in the future are already reflected in the market price.

In other words, all the daily changes recorded on an asset’s price chart reflect the factors that increase or decrease its valuation. In the case of bitcoin, which is influenced by multiple factors, its price changes reveal how demand, supply, regulations, community opinions and even network performance impact its value in the short, medium and long term.

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The second principle of technical analysis is that “the price of an asset always moves according to a trend.” These trendswhich are more like behavioral patterns, are closely related to general market sentiment.

Investors are generally driven by greed or fear. When there is a greater sense of greed, the market price tends to rise. Conversely, when fear reigns among investors and traders, the price tends to fall because there is more selling of assets.

indicator of fear and greed in the cryptocurrency market.
Investor sentiment plays an important role in price movements. Source: alternative.me

The third and final principle of technical analysis is that “market history is cyclical and repeats itself under similar circumstances.” If one event has influenced the price in the past, another similar situation could cause the same behavior. For example, if years ago a regulation banning the use of bitcoin negatively affected the price of the cryptocurrency, other similar regulations in different countries could have similar effects.

To find out how an event may affect the price of a currency, a historical price analysis can provide interesting data. Investors can compare whether events that have affected the cryptocurrency community have also had an effect on the asset’s price, as in the case of events such as the halving or institutional purchase of bitcoin.

The cryptocurrency market is particularly sensitive:

Cryptocurrencies are particularly sensitive and their volatility is much higher. But by analyzing these trends, users can conclude whether there is a higher expectation that the price will go up because investors are accumulating cryptocurrencies, or that it will go down because they are selling.

5 Essentials of technical analysis

Those who practice technical analysis are often in contact with charts and programs that facilitate the study of an asset’s behavior. These tools allow technical analysis to be more specific and reliable, with data or signals indicating the best time to enter or exit a market.

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Next, we will delve into some of the most commonly used tools in the cryptocurrency market to perform technical analysis.

Financial charts

Charts are tools commonly used by investors and traders to evaluate an asset. They are charts that record and order all the data about a market’s activity..

In the case of cryptocurrencies, we may have portals such as CoinMarketCap or Blockchain.com, which use bar or line graphs to represent summarized information about the volume or price of an asset. In this way, users can make historical comparisons.

CoinMarketCap’s charts allow users to examine bitcoin price changes over time. Source: CoinMarketCap

They are also very useful tools in financial markets, as the value of assets often changes rapidly and constantly.

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Candlestick charts

Candlestick charts, better known in the financial market as Japanese candles, are of the most widely used tools for analyzing price movements at any given time. For this reason, they are very useful for identifying trends.

Mostly represented as red and green bars, they signal data such as the highest and lowest price at which an asset was sold in a given period. Red generally indicates that the cryptocurrency has a downward movement, while green indicates an upward movement.

Japanese candles are one of the most widely used tools in technical analysis. Source: Investing.

Like other charting tools, candlesticks work on a scale represented by the “x” and “y” axes. On the “x” is all the market’s time information. That is, the time, day, and even month in which a particular activity was recorded. The “y,” on the other hand, shows all price data and their changes.

Indicators

When talking about trading it is essential to mention indicators, which are practically the right arm of every trader. These statistical tools are widely used to determine future market behavior. Some indicators generate signals that can facilitate the buying or selling of an asset at a given time.

Indicators have the ability to track trends in a cryptocurrency. In this way, they record the volatility of its price or the direction in which a particular asset is moving, which can be a bullish, bearish, or stable (also known as sideways) trend.

The chart exemplifies support and resistance levels in the price of an asset.
Resistance and support levels are an indicator used by traders to know at what price it is best to buy or sell their assets.

Some of the most popular market indicators are the simple moving average (SMA), which calculates the performance of an asset based on the closing price over a given period. There are also tools such as the relative strength index (RSI) and Bollinger bands that help identify investment opportunities and determine whether assets are overbought or oversold.

Learn more about bitcoin and cryptocurrency trading, both from principles. basics We at CryptoNews have several articles on this topic in our Cryptopedia. There you will find elements essential elements and you can also delve into the methods of investment o indicators key indicators of this market.

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