The explosive growth of the cryptocurrency sector has brought a vast number of retail investors to the space. Many are exploring ways of profiting through investing in crypto. However, the often volatile nature of cryptocurrencies presents both opportunities and risks for investors. Therefore, novice investors must take cues from successful veterans in the space to employ a sound investment strategy that includes a combination of fundamental and technical analysis.
Technical analysis involves understanding market sentiment by examining an asset’s historical price patterns and trends on a chart to predict future price movement. From moving averages to trend lines, analysts often use a combination of technical indicators to arrive at a sound investment decision.
Implementing a Smart Investment Strategy
For early investors and those who actively engaged in learning about the market and the tools required to maximize profits while minimizing risk, the cryptocurrency market has undoubtedly produced wealth that has changed people’s lives. According to a report released by Finbold, there are over 72,000 Bitcoin millionaire addresses as of early 2023.
Despite the potential for realizing lucrative returns in the industry, the nascent crypto sector is known for being highly volatile, with massive upward and downward price swings. This volatility and the entry of a new, inexperienced crypto investor profile fuel irrational investing decisions based on psychology and emotion. This article provides an overview of the cognitive biases that individuals routinely experience when making decisions about investing in cryptocurrencies.
Therefore, it is crucial for investors to reduce risk and possibly profit in the long run by consciously casting aside cognitive biases to arrive at a rational investment decision. Furthermore, smart investing requires an informed approach to critically evaluating each crypto project. This requires a combination of fundamental analysis and technical analysis.
Understanding Technical Analysis
Technical analysis (TA) is a central tenet of investment research that has been used in traditional markets for decades. Fundamental analysis (FA) determines an asset’s value by examining a project’s publicly available macroeconomic and qualitative data through a project’s whitepaper and online platforms. Conversely, TA solely analyzes past price action and trends on charts to forecast future price movement.
Investors and traders use a wide range of charting tools called indicators to conduct TA. Together, these indicators are used to assess market sentiment and determine opportune times for investors to enter or exit the market. At its core, TA is the assessment of charts to ascertain supply and demand in the market. The underlying premise of TA is that price fluctuations in an asset are not random and typically develop over time into discernible trends.
While there is no one size fits all approach to TA, there are common indicators that novice traders and investors can become familiar with in order to make potentially profitable trades.
Common Technical Analysis Indicators
Before delving into some of the most common technical analysis indicators used by crypto investors, it is vital to understand how charts operate. Charts are the backbone, and primary tool used when conducting technical analysis. TradingView, a well-known charting platform that gives investors access to a large selection of TA indicators, is an excellent place to start.
Price action is represented visually on charts. A candlestick chart is the type of chart that investors use most frequently when trading on global markets, including cryptocurrencies. This chart’s popularity can be attributed to its high level of detail compared to other charts like line or bar charts. Rather than condensing price action into a single data point as seen on line charts, candlestick charts provide four distinct visual cues for investors. This includes:
A bar and two wicks are used to visually represent candlesticks. The price is highest at the top of the wick and lowest at the bottom of the wick. A green or bullish candlestick body indicates that the value of an asset closed higher than its opening price in a specific time frame. A red or bearish candlestick body indicates a decline from its opening price.
Candlestick charts provide versatility for both short-term traders and long-term investors. Traders can use charts with time intervals ranging from one minute to daily to view short-term price action. For the longer-term investor, weekly and monthly charts offer a zoomed-out visual cue of price trends.
Support and Resistance Levels
Identifying support and resistance levels on a chart is a central component in technical analysis. Support and resistance refer to levels where asset prices typically bottom out or reach their peaks respectively. Resistance levels are the zones or levels where prices tend to pull back or decline, whereas support levels are discernible when asset prices tend to bottom out or experience a price rise.
Support and resistance levels provide insights into an asset’s supply and demand dynamics. For instance, price rebounds from a support level shows that the level of demand matches supply. On the other hand, resistance levels represent a point where demand no longer outpaces supply.
Levels of support and resistance are frequently tested. These thresholds can occasionally be breached, which causes support to change into resistance and resistance to shift into support. As a result, support and resistance levels function as a barometer to forecast price reversals and the emergence of new trends when levels are breached. Fibonacci retracement is a common indicator used by traders to identify support and resistance zones.
Revealing market trends is a foundation of technical analysis. All markets including the crypto sector move in trends. The three main types of trends include upward, downward, and consolidation or sideways price channels. Trend lines are a valuable method for investors to identify the direction of a particular asset.
Trend lines, as the term suggests, are plotted lines on charts that illustrate potential trends. These are lines that are drawn on charts to connect an asset’s high and low prices. A trend line that joins more data points typically denotes a stronger trend.
Another essential tool for determining the direction of a trend is the moving average. Moving averages reveal and summarize the average price of an asset over a defined period. Depending on the moving average’s time frame, they provide insights into long-term patterns or trends while helping to filter out short-term price fluctuations. The most widely utilized moving averages range from 50, 100, or 200 days.
Long-term moving averages reveal a more significant trend since they are less likely to be greatly altered due to short-term price fluctuations. Therefore, the more expansive moving averages benefit long-term investors. On the other hand, smaller data sets show more reactive trading, which typically helps short-term traders.
Moving averages provide valuable clues or signals of periods of bullish and bearish price action. For example, a crossover of two moving averages is frequently a clear indication of a narrative shift in price. A golden cross is often a bullish signal when a faster-moving average (50-day MA) crosses above a slower one (200-day MA). A death cross, on the other hand, denotes a bearish trend reversal when the average price over the previous 50 days falls below the average price over the past 200 days. This shows that the short-term price movement is no longer in line with the upward trend. Consequently, investors frequently interpret this as a sell signal.
Relative Strength Index
The Relative Strength Index (RSI) is a popular technical analysis indicator used by veteran investors and traders. It is a momentum indicator that shows whether an asset is overbought or oversold. This indicator is a straightforward line graph found below a price chart. Overbought and oversold territories are indicated by the graph oscillating between the values of 0 and 100, with 50 being neutral. A value of 70 or higher indicates that an asset has reached overbought zones, while a value below 30 signals oversold levels.
As with any technical indicator, analyzing an asset’s RSI is useful when combined with other technical indicators. For example, a price rally is likely to occur if a cryptocurrency tests support levels while its RSI reading falls below 30, as in the example above.
Trading and investors can gain valuable insights into potential price trends through technical analysis. However, it is crucial to remember that technical analysis on its own can be fallible. For instance, extreme market conditions caused by black swan events can completely derail technical indicators. Therefore, although it is a tool for spotting potential future market direction, technical analysis demonstrates probabilities rather than absolutes.
Trading is a decision tree.
The vast majority of people want “THIS is what will happen next”.
When in reality, you are just making a series of “If this, then that” decisions.
Which doesn’t have to be complicated, if you just accept that anything can happen.
— Lucky Chart Ape (@luckychartape) February 1, 2023
In order to have a well-rounded investment thesis, individuals must take into account the underlying fundamentals of a crypto project combined with technical analysis. Moreover, while technical indicators provide data, it is essential to accept that the interpretation of data is highly subjective. Therefore, it is vital to acknowledge personal biases before entering the market.