Investors interested in trading bitcoin have many tools at their disposal. Of all these options, technical analysis might be the most practical. Using this technique, traders can pinpoint key trends and get a better feel for market sentiment by analyzing bitcoin’s market activity, including price movement and volume data.
Armed with this information, technical analysts (sometimes called technicians or chartists) aim to make better-informed trades. By perusing market history and leveraging analytical tools, these analysts believe they can get a better sense of what a security will do next.
In this guide, we’ll cover:
- Technical analysis vs. fundamental analysis
- Key principles of bitcoin technical analysis
- Bitcoin moving averages
- Bitcoin support and resistance levels
- Additional resources
Technical Analysis vs. Fundamental Analysis
You can get a better understanding of technical analysis by taking a quick look at its counterpart, fundamental analysis. These two methods are some of the most widely used methods used in securities trading.
While fundamental analysts aim to determine what bitcoin should be worth by examining its key price drivers, technical analysts look only at the digital currency’s price history and volume trends. In order words, technical analysts only care about what bitcoin prices actually do, which they believe to be a result of supply and demand for the digital currency.
Technical Analysis Focuses on the “What”
In addition to harnessing fundamental and technical analysis, investors frequently seek to identify the factors that drive an asset’s price movements. However, isolating the specific causes of a security’s price fluctuations is not always easy. As a result, technical analysts focus not on the “why,” but the “what.”
While technical analysis can prove quite valuable for traders, not everyone considers it effective. The arguments for and against technical analysis might seem largely academic and theoretical in nature. To provide a better understanding of these points of view, this article will delve into the key principles that underlie technical analysis and its use in trading.
Key Principles of Technical Analysis
Technical analysis relies on several basic assumptions, which help lay the foundation for this pragmatic approach. While these underlying principles are largely based on academic views of the global asset markets, they can be broken down in ways that are easy to explain.
- Markets are efficient. Basically, what this means is that prices reflect all available information. As a result, current, former, and even future demand are accounted for in existing values. In the case of bitcoin, this might mean that former, current, and future supply are all known. Such an argument is easy to make, as the total number of bitcoins that will exist is capped at 21 million, and the rate of new supply is already known.
- Knowing isn’t crucial. While many investors seek to explain why security prices behave the way they do, certain factors can hinder these efforts. As events unfold, traders can receive more and more information, which can make it increasingly difficult for them to determine the underlying factors that drive an asset’s price movements. To overcome this, investors can simply focus on price history instead of causes.
- Price movements follow trends. Instead of moving randomly, prices follow short-term, medium-term, and long-term trends. Another way of putting this is that during a trend, a security that has been moving lower will continue to do so, while an asset that has been rising in value will keep up its upward movement.
- History often repeats itself. Observing market history has shown that over long periods of time, price patterns frequently repeat themselves. Many attribute this tendency for repetition to market psychology, which is driven by emotions like greed and fear. By examining chart patterns, technical analysts can evaluate these emotions to get a better sense of current trends.
- Trends can become self-fulfilling prophecies. In other words, if enough investors see the same pattern, they can take action to make sure that a prediction takes place. For example, if enough people believe that digital currency is the way of the future, and therefore expect bitcoin’s price to hit $10,000 per coin, they might collectively cause the currency’s price to rise to that level.
Key Role of Trends
Identifying trends is one of the most important aspects of technical analysis. Trends simply represent a price’s current direction, and can provide a better sense of where it will go next. Trends can be upward, downward, or sideways, and can exist over the short-term, medium-term, or long-term.
While identifying bitcoin’s price trends can be quite valuable, the digital currency’s price movements are quite volatile, experiencing several highs and lows during short time frames. Fortunately, technical analysts have a few tricks they can use to see through this noise.
Some of these tricks are simpler than others. If a trader sees that bitcoin’s price is experiencing lower lows and lower highs, he or she understands that the digital currency is in a downtrend. Alternatively, if bitcoin starts encountering higher lows and higher highs, that means the digital currency is in an uptrend.
Moving Averages
One trick that technical analysts can use to identify trends is moving averages. These averages help smooth out price volatility so technical analysts can get a better sense of a security’s trend.
The most basic kind of moving average is a simple moving average (SMA), which takes a security’s price values over a defined period, then averages them. For example, if bitcoin prices fluctuate between $500 and $600 over the course of 20 days, a technical analyst could determine the currency’s SMA by taking its price at the end of every session, then averaging those values.
Another option is the exponential moving average, which is similar to the simple moving average but emphasizes the most recent price values in a given time frame.
A perfect example of how a bitcoin trader could use moving averages involves calculating bitcoin’s 14-day SMA and 21-day SMA. If the 14-day SMA is higher than the 21-day average, this could indicate that bitcoin prices are in a bullish, or upward, short-term trend.
However, should the 14-day SMA fall short of the 21-day average, it could mean the opposite, that bitcoin prices are in a bearish, or downward, short-term trend.
If a bitcoin trader wants to take a longer view, he or she can calculate the currency’s 50-day and 200-day SMAs. In this case, a bullish trend would be indicated by the 50-day average exceeding the 200-day average, and a bearish trend would be shown by the 50-day average being lower than the 200-day average.
Support and Resistance
Another key tool used by technical analysts is identification of support and resistance levels. By identifying these levels, bitcoin traders can get a far better sense of supply and demand.
The basic idea behind support levels is that they are price floors where trader demand is strong enough to prevent any further losses. For example, if bitcoin prices form support at $1,000, this means that investors think any fallback toward this level makes the digital currency a good buy.
Basically, these price floors help illustrate demand for bitcoin. Should the currency’s price decline toward this support level, many traders will buy it, ensuring its price does not fall below $1,000. Knowing about this support level can prove valuable for technical analysts, as it can identify a price point where many traders consider bitcoin to be “oversold.”
Resistance levels are just the opposite; they are price points at which many traders step in and sell. For example, if bitcoin forms resistance at $1,200, this level is effectively a ceiling through which prices will have a hard time passing.
Should the digital currency form resistance at a level like this, traders will sell it as it approaches $1,200. As a result, resistance can be seen as indicating supply (the actions of sellers). In addition, these price ceilings might reveal points at which traders consider bitcoin to be “overbought.”
Additional Considerations
Technical analysis can be very helpful for bitcoin traders, making it easier to evaluate market sentiment, identify trends, then use this information to make better-informed decisions.
However, there are several important considerations you should keep in mind if you are thinking about using this method.
For starters, not everyone agrees about the efficacy of technical analysis. Some have criticized the practice, stating that if the market has already incorporated all available information into asset prices, technical analysis is not constructive because the price history it uses has already been taken into consideration. Others simply prefer fundamental analysis, believing it to be far more effective than reading charts. (Read our guide to Bitcoin Fundamental Analysis here.)
However, the two can certainly coexist. For example, you could use fundamental analysis to evaluate whether bitcoin’s price makes it undervalued or overvalued, then leverage technical analysis to find an ideal entry point. Alternatively, you could harness technical analysis to determine a good time to sell and then use fundamental data, such as the ongoing scaling dilemma, to help confirm this decision.
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Additional Resources
Bitcoin technical analysis can be found at:
Economies.com: frequently updated reports focusing on technical analysis
TradingView.com: crowdsourced technical charts, with comments
NewsBTC.com: occasional reports on bitcoin technical analysis
TheChartGuys: daily updated video on bitcoin technical analysis
