Forget Technical Analysis. Let’s talk about cricket. ICC says that 90% of the total 1 billion cricket fans globally are from India, so I think it would be wise to talk about something you already enjoy to the core, assuming that you do fall in the 90% category.
Rapidly moving on.
So when you see Virat Kohli heading to the pitch, what is the first thing that you and your family/friends/colleagues do? Probably how much he is going to score in this match?
But when you have to predict Virat’s batting score in an ongoing match, you don’t do it just randomly, right? You do that by looking at his form. Go deeper and you will find that you determine a player’s form by subconsciously recalling their recent statistics, like batting average, strike rate, record against the opponent, and more. Apart from this, certain other elements like dew factor, pitch type, weather conditions, humidity, etc. will also help you estimate the degree of batting difficulty for him. So in a particular match, taking all these factors into account, if you say that Virat would score somewhere around 70-90 runs, would it be a plain guess? Certainly not.
Maybe you don’t realise that, but you just used so many indicators and trends to guess his batting score for the match. But at the same time, you also know the probability of Virat going duck out, despite all his great form and recent innings, exists.
You know you are not the only one who does that and such analysis is not a hoax when I remind you about the huge market that breathes on such well-calculated speculations in Cricket.
So what did you just get to know? It’s that you often use Technical Analysis to predict a value in your favourite sport.
Yes you do! Let us now talk about Technical Analysis.
What is Technical Analysis
Technical Analysis is the study of past price data to identify upcoming trading opportunities in the cryptocurrency market. A technical analyst uses estimation models, price & volume charts, and other technical indicators to anticipate a change in the market and takes an informed decision while trading cryptocurrency.
Application of TA is not a platform or asset-specific matter. In actuality, TA can be applied to any asset that generates data in any form, which can be used to forecast the market of that particular asset. In fact, you apply TA on a daily basis without even knowing it.
For example – You know buying iPhone 8 after the launch of iPhone X would be more economical because the price of the iPhone 8 would drop with the arrival of iPhone X. You are aware that buying an apparel during its off-season saves you money due to low demand.
Why Technical Analysis
So how do you predict the price movement of any item? You do it with the help of patterns you observe in the data that you have accumulated in your head from noticing price trends. Similarly, when you carry out TA for a particular asset, you look at the past data to observe and identify patterns in order to forecast the direction of the market.
Clearly, as the goal is to forecast the market with the help of past data available, TA is not the sure-shot path to success and may fail if the market takes an unexpected turn. So remember, TA is nothing like a magic wand you can spin to rain profit, it is rather a pathway to get more ‘Rights’ than ‘Wrongs’ so that your probability of success is higher than failure.
Difference between TA and FA
There has always been a long-standing debate between Fundamental and Technical Analysts regarding which one of the two is a better way of analyzing the price movement in the market. Not trying to play pragmatic here, but I think both fundamental and technical analysis are significant in evaluating the upcoming opportunities in the market.
While on one hand, FA focuses on estimating the future market of an asset by measuring its intrinsic value, TA assumes that the price action of an asset can be forecasted with the help of technical indicators and patterns in its price and volume charts. When we say intrinsic value, we mean the value a company represented by the present available information about it , like blockchain solution integrity, security model, business model, white-paper, coin metrics, scalability model, feasibility, and more, to estimate the future evaluation of the same.
To say that one is more valid than the other would not be entirely true because FA is a better discipline when it comes to long-term investments, whereas TA is more valid when we are talking short-term investments or active trading. So if one wants to invest in a cryptocurrency with an aim to exit with a fair profit after, say 5 years, FA would be the way to go about it. In another scenario, if one wants to trade a cryptocurrency as per the opportunities in the market, TA is what they should go for.
The best approach to trade cryptocurrencies would be to practice a combination of both, so that you start out by investing in a fairly promising cryptocurrency asset with the help of FA and then identify the price trends, patterns and indications hidden in the price data of that cryptocurrency asset using TA to anticipate the market for good.
So that was a brief start to this module in which we will discuss what Technical Analysis is, why it is needed, and how an active trader can use the concepts of it to identify patterns in cryptocurrency trading in order to stay ahead of the curve.
The concepts of Fundamental Analysis have been discussed in Module 3.
Assumptions in Technical Analysis
The reason why Technical Analysis and Fundamental Analysis exist as two different analysis methodologies, is that the former is in clear contrast to the latter in terms of the underlying principle. While FA implements that the fundamentals factors of a cryptocurrency asset need to be analysed in order to forecast its valuation, TA does not have anything to do with analysing the fundamentals. TA focuses on deriving embedded information from price and volume charts to make investment decisions.
Essentially, Technical Analysis is backed by following three basic assumptions:
The Market Discounts Everything
Unlike Fundamental Analysts who believe in forecasting the market for a blockchain company by studying the intrinsic value of its cryptocurrency, Technical Analysts presume that the effect of anything that could influence the market for a blockchain company reflects in the price & volume charts and trading history of its cryptocurrency. According to Technical Analysts, the trading data of a cryptocurrency is representative of the fundamental elements of the respective blockchain company, which is why, for them, the need to analyse the fundamentals is eliminated.
Price Moves in Trends
Another belief associated with Technical Analysis is that the price action of a cryptocurrency is influenced by trends. So if a noticeable number of investors are buying BTC, a buying trend would be established, encouraging other investors to buy the same. Or if a large number of investors are pulling their money out of the market, the consequent trend would cause a further sell out.
History Tends to Repeat Itself
The third assumption in Technical Analysis has a lot to do with market psychology. Technical experts believe emotions like Fear, Uncertainty, and Doubt (FUD), FOMO (Fear Of Missing Out) etc., play a huge role in steering the market for a cryptocurrency. So if a particular event or a time period, associated with the rise, fall, boom, or crash of a particular cryptocurrency, comes back around, the investors tend to react in the very same way they did the last time, the time before that, and so on.
Advantages & Disadvantages of Technical Analysis
Just like anything in the world, Technical Analysis also has its own set of advantages and disadvantages. However, the point of discussing these two polar aspects of it is not to advocate or discourage its abilities, but only to table an unbiased view of it. Just for the information of readers, TA is a complete cryptocurrency market analysis methodology in itself and is being practised by a large number of cryptocurrency investors to date.
One of the most rational justifications for why one should use TA is that it involves the psychological aspect of the cryptocurrency market. There is no doubt about the fact that the market for any cryptocurrency is heavily influenced by investors’ sentiments, which is why including the market psychology in any market analysis methodology becomes crucial. TA takes into account the psychological aspect of the market which is clearly reflected in the form of patterns and indicators in price charts.
Something that is not possible to be figured out via Fundamental Analysis is a trend. A buy or sell out trend established in the cryptocurrency market could pertain to a psychology among investors, anticipation of a historical uptrend or downtrend, or even a random cause. Such a trend of any magnitude will always be visible in trading activity and price action of the cryptocurrency. And as FA has nothing to do with analysing the trading activity, TA is the only way to notice a set or growing trend and make an investment decision in time.
All the signals and indicators are clearly visible in the trading activity, which is why most investors agree that TA makes immediate changes in the charts and upcoming trading opportunities more perceptible. This allows any investor with a fair knowledge of TA to read and use patterns in the charts and start trading right away at any point of time. FA on the other hand, at the bare minimum, requires complete study of the company, which is a time-taking process.
Learning TA is a one-time thing. That’s because the utility of TA does not change with a company, industry or sector. You learn the concepts of TA, you learn how to use it, just once; its usability does not vary in any case. Compared to TA, FA would require you to start over, every time you plan to invest in a new cryptocurrency.
At times, Technical Analysis could be confusing, especially when different patterns in the price and volume charts signal different trade actions at the same time.
More often than not, the point which Fundamental Analysts put up to substantiate their opinion on FA being a better market analysis discipline than TA is that the latter does not consider the cause beneath a trend or market psychology. It only concerns what is upfront or can be forecasted, from a price perspective. So, according to Fundamental Analysts, TA is a superficial method of forecasting, which is not backed by factual information.
Since TA extracts information from trade activity and price actions, which are basically lines and shapes, accuracy matters. However, accuracy is not a matter of concern here. Technical analysis is kind of applied science, and accuracy in it comes from months and years of practice with real investments. But, to say the least, once you master the art of TA, cryptocurrency trading is so much fruitful and fun.
Soon after Technical Analysis became a jargon in the financial world, experts deduced that any price change at any particular time is uniformly distributed across the stock market, which is why one cannot predict the price of a stock going by its historical data. The first economist to bring this hypothesis to light was Burton G. Malkiel in his book ‘A Random Walk Down Wall Street’, which is considered a timeless creation of his. With an interesting analogy, Burton compared the price movement to the walk of a drunken man as you cannot predict where exactly he would place his next step. This theory is called ‘Random Walk Hypothesis’ (RWH), which implies that the market for any stock or cryptocurrency is unpredictable.
However, technical analysts believe that the market is predictable with the help of technical indicators and signals, which is basically the whole point of TA.
Another theory that backs RWH is Efficient Market Hypothesis (EMH), which implies that the market is efficient enough to reflect the exact and fair value of stocks or cryptocurrency units at any point of time, which makes it impossible for an investor to beat the market in order to make a profit unless they do it by chance or investing in high-risk options. Proposed by Eugene Fama, the father of EMH, the theory advocates the assumption that generating substantial profit or returns on a regular basis, using either of TA and FA, is not possible, which applies to all investors of all sizes as the market rapidly adjusts to any information or news, once it goes public. This leaves zero to negligible chance of an investor taking advantage of the available market data to profit from the consequent change in price.
However, experts and analysts do not conform to either of the two theories, asserting that markets can indeed be outperformed with adequate analysis, and that several investors have almost consistently beaten the markets.
Similar to traditional markets, cryptocurrency markets are also driven and shaped by investor sentiments. Therefore, these hypotheses, valid or invalid, apply to cryptocurrency trading as well. Since inception, cryptocurrency markets have behaved much like traditional markets, exhibiting sentimental influence on price and volume. For instance, the Bitcoin Selloff in 2017 was expected to create a boom in the price of Bitcoin due to the upcoming fork in August. Investors injected money into Bitcoin expecting to get the new coin generated, which was BCH, and that resulted in a buying uptrend, taking the price of BTC to approximately $3,000. Apart from this, investors frantically sold off Bitcoin when the Chinese government decided to declare a nationwide ban on Blockchain ICOs, followed by a ban on cryptocurrency trading. This resulted in nearly a 37% price drop for BTC, which was critically detrimental to the BTC price already reaching new highs of $5,000.
These examples clearly show that cryptocurrency markets, just like stock markets, are affected by market sentiments, indirectly linking the utility of analysis to cryptocurrency market prediction.