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.
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
- Crypto of the year: Is Cardano destined to change the world?
- Is HODLY An Ideal Crypto Wallet?
- Technical analysis and cryptocurrencies: Does it make sense?
- Cryptocurrency NEO: Digital assets with the ambition to change the world
- Cryptocurrency forks: What are the benefits for the end user?
- Dogecoin: A joke that someone turned into reality
- Bitcoin: Pros and cons
- Dash: Learn about its potential
- Cryptocurrencies: Keeping them safe (Trezor + Ledger)
- The Three Point Checklist Before Getting into Bitcoin