To the uninitiated crypto user, technical analysis could be seen as fluffy divination with over-complicated lines and numbers, much like predicting life events through astrology.
Technical analysis is actually more than just pseudoscience, it is a study that combines mathematics and psychology, a study of price patterns and market sentiments. It tries to explain the correlation between market sentiments and price actions, to predict market movement that assists in making a decision.
The base foundation of what makes a chart, candles represents the price action within a fixed time period. To look at a 1-hour candle would mean the price action that happens all in that 1 hour, a new candle will form after the hour is up.
Shadows indicate price action that happened during the duration but outside the opening and closing of the candle, it forms from the highest and lowest point of that time frame.
Typically a long upper shadow will indicate a price drop soon as the prices hits the high it was quickly brought down by bears before the close. A long lower shadow will indicate bulls buying up. The bigger the difference between the upper and lower shadow’s length can accurately predict how the next candle forms.
Candles are separated distinctively by colours. When a candle closes higher than it’s open, it’s denoted by green and it’s a bullish movement, the reverse is true for red candles denoting a bearish movement when it closes lower than it’s open.
Candlestick colours may vary from different exchanges, Chinese or Korean exchanges might use red for bullish candles and blue for bearish candles instead.
As primitive as drawing lines plotted between two points. Lines are drawn using common repeated points from the bottom of candles are also referred to as support line. If they are drawn from the top of the candles are resistance line. They are simply patterns (or trends) identified over a period of time.
The psychology behind a rising support line is that the price is well supported by more traders are on long and have a higher target price they are not selling and even possibly adding to their long positions.
A dropping resistance line would indicate price not going beyond the resistance. Bears are selling as soon as it hits this resistance line, adding onto short positions.
Once a trend line is broken, it’s a reversal of a trend. It’s best to make a decision only when there is a confirmation of reversal when the last candles close convincingly and form well above or below their previous trend lines. Be wary of those long shadows as bears and bulls struggle to decide the next coming candle.
There are many indicators out there, some modified over time for robustness and accuracy. It is simply too vast to cover but they are generally separated into 2 categories- Overlays and Oscillators. They help to make more sense of the information that is available on the charts through the use of mathematics.
Overlays are plotted on top of the charts, with data of candles. Shown here is Moving Average, taking an average of closing prices of 20 candles. The more candles taken into account would show a more macro view.
The main aim is to eliminate sudden changes by taking an average of past candles to form a more stable trend line.
Oscillators are separate from charts with their own 0–100 values. Above example is RSI or Relative Strength Index to determine if something is overbought (above the blue band) or oversold (below the blue band).
Plotted within a minimum and maximum range, they show the momentum of price action and on the basis that if something is overbought, it has to go down soon and if something is oversold it has to go up soon.
Technical analysis has come a long way since it’s inception since the 1700s. The core concept behind it is that it is a self-fulfilling prophecy. Traders see the same thing and acting towards its predictions.
It is the attempt of trying to correlate psychology of greed and fear using statistics to identify trends, mankind’s obsession of pattern recognition to form confirmation bias.
Technical analysis is not the be-all and end-all, there are still things charts cannot explain and, especially in artificial intelligence era, traders are now bots with algorithms that can make decisions of more data points that could use charting against the human trader.
Bots today are even trying to quantify and understand fundamental analysis. It is only a matter of time that traders are displaced with engineers.