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Technical analysis and cryptocurrencies: Does it make sense?

Technical analysis is the most widespread tool used by traders to predict future market developments. It is relatively simple and if used correctly, fairly efficient. The question is: Does it make sense to apply technical analysis to cryptocurrencies, known for their high volatility due to low market capitalisation  and sensitivity to changes with the change of a single fundament?

Technical analysis as such

The goal of technical analysis is to predict the evolution of currency rates, shares, commodities or cryptocurrencies by using charts. Technical analysis can only use what’s visible i.e. information shown in a chart.  This information includes opening price and closing price, high and low. The prerequisite for conducting a technical analysis is a hypothesis that history repeats itself.

Technical analysis is in fact based on trading psychology. No matter whether an instrument is overbought or oversold, whether the asset is a currency pair or gold. Traders’ behaviour is always the same. They all rush to save themselves. This extreme example shows that traders tend to show the same behaviour, which is reflected in a chart. The technical analysis offers a pattern that can be used for developing a trading strategy.

Technical analysis and cryptocurrencies

In the previous sectio,n you could read that traders’ behaviour is always the same no matter whether it comes to gold or a currency pair such as EUR/USD. It’s true. Emotions work in the same way regardless of how successful the trader is. Having in mind what I said before, you may ask if the technical analysis works in cryptocurrencies. My answer would be: YES, it does!

To claim that technical analysis does not work in cryptocurrencies would be a very bold statement.

„Very bold“ depends on the angle you view things. If you are a supporter of the theory of efficient markets you assume that all information including history is reflected in the exchange rate and  that technical analysis is inefficient. Markets’ efficiency changes in time, which is at least the same bold statement as the one before.

The question should not be if technical analysis is efficient, but in which configuration it is efficient. If a market is volatile (in our case due to low capitalisation) it sends plenty of false signals If you are aware of this (…and in the case of cryptocurrencies you surely are) you can anticipate this happening. Try out a different timeframe, a different setting of indicators (a different period). Use more than one technical indicator at a time to create  a filter against false trades.

One of the disadvantages of using technical analysis for cryptocurrencies is low market capitalisation of cryptocurrencies compared with traditional assets. If the crypto market is severely hit all traders will be eager to sell immediately and the price may unexpectedly plummet. This brings us to a next reason or disadvantage.

Another reason why technical analysis sometimes fails when applied to cryptocurrencies is the “pump and dump” scheme. (In the future we are going to spent more time on this phenomenon well-known among crypto traders). In a nutshell: A group of traders agrees that they all, at the same time, start buying a single crypto with low market capitalisation. This behaviour may result in multiplying the price within a few minutes bringing profit to the group of traders after selling the crypto. In such a situation, no technical analysis will help.

yoyo-pumpanddump

A small pump and dump on Yoyow a few days back. The price skyrocketed within 5 minutes from sat 1700 to 2500 and then fell.

Basic technical analysis always makes sense

Although you are a fundamental trader, you should use technical analysis in order to identify future trends or important support and resistance levels. If you are a technical trader don’t fear to use technical analysis for cryptocurrencies.

One advice in the end. The rule that “less is more” works in this field. Don’t combine more than 3 to 4 indicators. Otherwise, you will overkill your chart making it useless. I know many people who “improved” an efficient trading strategy received from their friends for free into a loss-making one.  

Further info about cryptocurrencies

Author

J. Pro

More about the author: J. Pro

Unlike Stephen (the other author) I have been thinking mainly about online business lately. I wasn't very successfull with dropshipping on Amazon and other ways of making money online, and I'd only earn a few hundreds of dollars in years. But then binary options caught my attention with it's simplicity. Now I'm glad it did because it really is worth it. More posts by this author

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