On paper, it sounds easy enough and for some people, it often is, but (and that is a very big but) the fact that you are reading this article probably means you are not one of those people. The good news is that you can become one of those wizards that use the technical analysis to their benefit and make their living by knowing the cryptocurrency market like the back of their hand. This article is by no means a definitive guide on market analysis, but more of an introduction to the topic. After reading it, you will at least have an idea whether spending the time and effort on getting familiar with technical analysis is something you want to do.
Technical analysis isn’t a new thing on the financial market. Its roots go back to 17th-century Dutch traders and their methods of predicting the market. While today’s methods are far cry from those used in the 1600s, the idea is the same, using the existing data to predict the future movements on the market. Basically, it is thought that market fluctuations aren’t entirely random and as such, can be predicted with a varying degree of success.
Further development was brought by Homma Munehisa, a rice trader from Tokugawa Japan in the early 18th century. His book, The Fountain of Gold – The Three Monkey Record of Money, is considered to be a pioneer work in market psychology and the original guide on how to corner the market.
Technical analysis as we know it today is heavily based on Dow theory. Charles Dow (1851–1902), founder and the first editor in chief of Wall Street Journal, also established Dow Jones Industrial Average, AKA Dow Jones, the stock market index design to reflect the overall state of the markets. His theory, or rather the theory named after him, since it was formulated after his death on the basis of his editorials, defines several points from which modern market analysis draws its effectiveness even today, and any wannabe cryptocurrency trader should be familiar with them. Here are few of the most important ones:
- Each market trend has three phases. Phase 1 is when investors linked to the commodity start trading. They know what is going to happen and trade accordingly. Since their volume isn’t very big, the price usually doesn’t fluctuate much, until the trend reaches Phase 2. This is when the rest of the markets becomes aware of their actions and starts mimicking them. The volume increases sharply and prices react accordingly. People start speculating wildly and at this point, the investors who pay attention to trends start distributing their assets, which is known as the Phase 3.
- Trends must confirm each other. Charles Dow noticed that the best indicator of the health of manufacturing sector isn’t the state of factories, but rather the state of the transport industry. Goods manufactured all over the United States must be transported (by rail in his time) and thus as long as the average volume of goods shipped corresponds with the averages of the goods produced. Once the two start diverging, it is a sign for concern.
- In order for the trend to be created, a sufficient volume must be present. It isn’t enough that the price is changing. It may be an isolated incident or a freak occurrence (like the CEO of Intel selling his stock right before the company revealed a flow in their processor design). Only when it reaches a certain volume, we can start talking about a trend being established.
The practical application
The modern technical analysis uses tools undreamt by late Charles Dow. Instead of painstakingly going through the data accumulated of hundreds of years on paper, today’s analysists use raw computing power to crunch the numbers and recognize trends. What used to take days or even weeks of going through the records is achieved in mere seconds by computers and software designed specifically with predicting trends before they appear on the mind. That is why technical analysis is a must when it comes to dealing with cryptocurrency market, where the situation changes by the minute.
Getting a jump on a trend is a wet dream of every bitcoin trader out there. The ability to predict charts is a like a shortcut to becoming a bitcoin millionaire. And recognizing trends is a tricky bit. Even the most experienced traders can make mistakes, despite their knowledge and tools at their disposal. Paying attention to moving averages, points of resistance, support level, and volume are essential when trying to predict charts and trends, but when everything said and done, it isn’t an exact science. There are too many moving parts and influencing factors for even computers to make a 100% correct assessments every time, especially when human emotions get into play, as they often do when a lot of money is on the table.
Every bitcoin trader should be aware that there are severe restrictions on technical analysis. For the most part, the critics claim that the process pays too much trust on another Dow Theory principle, stating that the market discounts all news. Quite often, the information doesn’t reach the general public and prices don’t always reflect them, despite the efficient market theory. It also can’t incorporate fraudulent behavior, like insider trading or Mt. Gox scandal, but then again, no tool can. Still, any bitcoin trader worth their salt should be aware of this possibility and adjust his or her position accordingly.
Still, market analysis can be a powerful tool if used correctly, but it will yield best results if used in conjunction with other methods, like fundamental analysis. Technical analysis deals poorly with undervalued or overpriced coins and that represents a significant risk when relying solely on it when dealing with the market. At the end of the day, every trader has to use the oldest tool in human history to determine whether the trade is a good idea: common sense.
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