The Basics of Technical Analysis
Before entering the digital asset market, investors may consider digging into methods of pricing crypto currencies: technical, fundamental and quantamental analysis. Today, in this note, we will explore how technical analysis is applied in the context of digital assets pricing.
Technical analysts believe they can predict future price movements based on the past performance of assets. This approach involves detecting support and resistance levels in the historical price chart by examining price movements and trading volumes.
The historical price and volume chart represents all the past decisions taken by market participants (buying and selling) and will affect future participant decisions in two ways:
- Psychological, as what you did in the past affects how you approach future situations. For example, many traders tend to focus on the price at which they bought an asset, and if it declines, they want to sell when it reaches break-even again.
- Reflexive: some traders identify trends and chart patterns which are common, and act accordingly. It is expected that these chart patterns will follow the expected outcome and that the trend will likely be sustained by more and more participants joining the trend.
The price and volume charts allow investors to detect support, resistance levels and analyse the trend:
- Support level: before buying, an investor might wait till the price goes down to a level that would be perceived undervalued (“buy low”). Each time the asset reverts to this specific price level, the investor might decide to add to his position at the lower level. As more investors buy at this level, the quicker prices would bounce back up, creating a short term floor, called support level.
- Resistance level: when investors already have an exposure on an asset and the price is moving to an overvalued level, they might decide to take their profit (“sell high”). Similarly to support level discovery, the more sellers that sell at the same level, the more firm the cap.
- Trends: in addition to support and resistance levels, an investor or analyst could try to analyse the trend. If an asset has broken several resistance levels by hitting new highs, the trend would be upward. Symmetrically, if an asset has fallen through several support levels, the trend would be downward. This analysis can help reveal whether a trend is likely to continue or change, enabling traders to make considered decisions on their short-term strategy.
Support and resistance levels are found on the historical price charts by looking at the frequency of these levels and the volume that constitute them. Supports and resistances are only temporary floors and caps, which would be broken when the market sentiment changes over time.
As an example, on the 26th of Nov, Bitcoin has hit a resistance level all time high (ATH) and many sellers will take the opportunity to take their profit.
Finally, some traders might complement this analysis by using other advanced tools such as:
- Moving Averages (MA),
- Moving Average Convergence Divergence (MACD),
- Open High Low Close (OHLC),
- Bollinger Bands,
- Relative Strength Index (RSI)
In summary, even if it is always difficult to get the right timing when trading an asset, following the principles of technical analysis will guide your investment decisions.
If you decide to be less price sensitive, you might opt for a diversified index, where movements are smoothen by the various assets in the index. At Trakx.io, we offer Crypto Traded Indices (CTIs), to get an easy exposure to thematic strategies similar to ETFs in traditional finance. Investors need to select the thematic that meets their investment objective and match it with one of our various products, such as Top10 DeFi, Lending, Diversifier, Digital Inflation hedge, Vol controls, Decentralised and/or Centralised exchanges.
To be followed next week with another method of Crypto Asset Valuation.
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