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Trading 101: Technical Analysis Explained

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2022-07-01
Trading 101: Technical Analysis Explained
Technical analysis can make trading more efficient and less risky. This article will brief you on the most common crypto indicators and how they are used for profit generation.

Difference between technical analysis and fundamental analysis

We've discussed fundamental analysis (FA) before and agreed that in crypto markets, fundamental analysis (FA) gives a more thorough understanding of each coin/token. However, as (relatively) short-term profit gainers, traders will favor technical analysis (TA) over FA despite its inherent limitations (lack of historical data, Bitcoin's high dominance, etc.).
The key difference between these two strategies is the scope of the evaluation. FA takes into account everything that affects the asset's intrinsic value, while TA relies mostly on charts, patterns, and trends to predict its future performance. In short, FA is made up of qualitative and quantitative research, but everything TA needs is the latter.

Seven assumptions and principles for technical analysis

The theory of technical analysis is built upon the three basic assumptions below:
Assumption #1: The market discounts everything.
This assumption highlights the difference in technical analysts' beliefs. Rather than exhausting themselves with FA, TA adopters have a keen eye on prices as the output of all relevant information. That is, the price of a security naturally reflects the quality of financial statements, the quality of a company's management, etc. Put it in crypto, and prices should contain powerful information on adoption rate, governance, utility, community, and hashing difficulty/emission rate.
Assumption #2: Price always moves in trends.
Detached from any time frame in consideration, prices remain the deciding factor for TA. Beginners may find themselves dumbfounded by the numerous candlesticks and lines appearing on the screen. Believe it or not, we've all been there. When you get used to it, you'll always see a trend because prices have to move in the same direction once the trend is created.
Assumption #3: History repeats itself.
Some would argue that this is the most important assumption for TA as psychological, emotional and rational factors all come into play here. Should a situation involve the same factors and conditions as in the past, we can very well expect the same outcome. Even if we personally don't, the majority will, creating similar market sentiment and leading to similar trading behavior.
In addition to these given principles (yes, we need to accept them as true without proof), there are some other universal principles formulated by market participants over the years, namely:
Principle #1: Trend continuation is more likely than reversal.
Take this as an extension of Assumption #2. As prices always move in the same direction, catching the exact changing turns sounds appealing because they represent the best opportunities for profit maximization. However, we advise you to make good use of scalping and swing trading, which can guarantee you easy money in a trend.
Principle #2: Market alternates between range expansion and range contraction.
Markets usually exist in two trend types: one-way trends ( bullish/bearish) or sideways. Normally, strategies that work well in one-way trends will not work in sideways and vice versa. Bitget's newly released products, Bitget Spot Grid Trading and Bitget Futures Grid Trading, are vivid examples of tools which will deliver the best result in bumpy markets such as Bitcoin at the moment (swaying around the US$20K mark), but we do not recommend using these two in a fully bearish/bullish trend.
Principle #3: A trend ends in either a buying or a selling climax.
Eventually, prices will reach a climax at the end of a trend, where sharp movements and heightened trading volume take place. As mentioned above, selling or building climaxes appear very seductive, as extreme sentiment often comes right after climaxes.
Principle #4: Momentum precedes price.
Think for a moment: No matter which phase the market is currently in, it has to start with a one-sided trend, loose the steam and trade in sideways, then some small, reverse moves before returning to the original direction. That being said, it's often better to bet on the continuation of a trend, especially after a sharp move.
These seven assumptions and principles are the roots of TA. Whenever you feel overwhelmed by the numbers, read these again and you'll be fine.
Basic indicators for crypto technical analysts
Even though TA is heavily quant-based, we don't have to do all the calculations ourselves. The most widely used charting tool for all types of traders is TradingView, which is integrated into Bitget as well.
Trading 101: Technical Analysis Explained image 0
Bitget Spot Trading
Moving Averages
An average price is calculated by doing the sum of historical prices and dividing this sum by the total price points included. The moving part is added to say that the price average is constantly re-calculated based on the latest price data. There are several variations of moving average (MA), including:
  • Simple Moving Average (SMA): Basically what we've discussed above. SMA is used to define support and resistance levels to help traders know when to enter or exit the market.
Trading 101: Technical Analysis Explained image 1
This is an example of a 9-day SMA, which means that every data point is equal to the sum of closing prices in the last 9 days divided by the total points.
  • Exponential Moving Average (EMA): EMA is more sensitive to recent changes as it gives more weight to most recen t price points.
Trading 101: Technical Analysis Explained image 2
Let's add EMA to the chart. We can see here that the EMA converges more to the candlesticks than the SMA, meaning it's more responsive.
  • Moving Average Convergence Divergence (MACD): While SMA and EMA are solely price-following, MACD is trend-following, i.e. more suitable for trend identification. MACD is calculated by subtracting the 26-day (long-term) EMA from the 12-day (short-term) EMA.
Trading 101: Technical Analysis Explained image 3
The blue line represents the MACD line or the fastest MA (MACD=12-day EMA - 26-day EMA), the red line a signal line (the slowest MA) which is the 9-day EMA of the MACD line and the red columns are called the MACD histogram or the difference between the two.
Relative Strength Index (RSI)
RSI is intended to chart the current and historical strength/weakness of an asset in a recent trading period. It is also trend-following.
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The two typical RSI levels are 30 and 70 (on a scale of 100). 30 or below signifies an oversold, the price is lower than the actual value so buying is justifiable. In contrast, 70 or above is the overbought level, where people over-appreciate the asset.
Average Directional Index (ADX)
Now that we have determined the trend, we need to know how strong it is. That's when we use ADX, which is based on the directional movement of prices. Similar to RSI, ADX value can range from 0 to 100, with 25 and below indicating an absent or weak trend.
Trading 101: Technical Analysis Explained image 5
Let's see the chart here. BGB's oversold period lasted for approximately 10 days, and the trend kept getting stronger until BGB price bounced back and RSI hit 30 again.
Accumulation/Distribution Line
This is a volume-following indicator. Accum./Dist. Line measures the capital flow into and out of the market, giving insights into traders' behavior. Accumulation means traders are buying and Distribution means they are selling.
Trading 101: Technical Analysis Explained image 6
Above we have MACD and RSI suggesting a bullish trend for BGB, which is supported by the Accumulation at the bottom chart.
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