Complete Guide To Technical Analysis For Crypto (+Bonus Test) PART 1

Everybody who invest in crypto has heard of Technical Analysis. Many recognize the term as analyzing charts and predicting price pathways. The ease of it carries a great deal of risk, as layman's basicly play the game of connecting the dots, and drawing lines so that they can later bet their hard earned money on their drawings. And I don’t blame them, it’s so tempting. But TA is far from easy, and drawing fancy lines or knowing basic indicators like Volume, MACD or EMA is only one segment of it. Others are: risk management, money management and position sizing, trading psychology...

I know all of this because I’ve made those mistakes. In order to perfect my financial literacy, I’ve started learning in accordance with CFA (Chartered Financial Analyst) Level 1 exam.

The CFA program is a globally recognized standard for measuring the competence and integrity of financial analysts. Level 1 focuses on tools and concepts that apply to investment valuation and management.

In this reading, I will share with you EVERYTHING I’ve learned so far. From basic theory on why TA works, graphics tools and indicators, to trading psychology, online free sources to learn trading, to recommending books to read. As I don’t want to post it all at once because it will be a large 30+ page document, it will be divided into parts.

Part 1 will serve as an introduction to Technical Analysis theory, why does it work, who are the pioneers an how it is compared to Fundamental Analysis. Let’s begin.

INTRODUCTION

Technical analysis has been used by traders and analysts for centuries, but it has only recently achieved broad acceptance among regulators and the academic community. This reading gives a brief overview of the field, compares technical analysis with other schools of analysis, and describes some of the main tools in technical analysis. Some applications of technical analysis are subjective. That is, although certain aspects, such as the calculation of indicators, have specific rules, the interpretation of findings is often subjective and based on the long-term context of the security being analyzed.

This aspect is similar to fundamental analysis, which has specific rules for calculating ratios, for example, but introduces subjectivity in the evaluation phase.

TECHNICAL ANALYSIS: DEFINITION AND SCOPE

Technical analysis is a form of security analysis that uses price and volume data, which is often graphically displayed, in decision making. Technical analysis can be used for securities in any freely traded market around the globe. A freely traded market is one in which willing buyers trade with willing sellers without external intervention or impediment. Prices are the result of the interaction of supply and demand in real time. Technical analysis is used on a wide range of financial instruments, including equities, bonds, commodity futures, and currency futures.

The underlying logic of technical analysis is simple:
■ Supply and demand determine prices.
■ Changes in supply and demand cause changes in prices.
■ Prices can be projected with charts and other technical tools.

Technical analysis of any financial instrument does not require detailed knowledge of that instrument. As long as the chart represents the action in a freely traded market, a technician does not even need to know the name or type of the security to conduct the analysis. Technical analysis can also be applied to any time frame—from short-term price movements to long-term movements of annual closing prices. Trends that are apparent in short-term charts may also appear over longer time frames. Because fundamental analysis is more time consuming than technical analysis, investors with short-term time horizons, such as traders, tend to prefer technical analysis—but not always. For example, fundamental analysts with long time frames often perform technical analysis to time the purchase and sale of the securities they have analyzed.

Principles and Assumptions

Technical analysis can be thought of as the study of collective investor psychology, or sentiment. Prices in any freely traded market are set by human beings or their automated proxies (such as computerized trading programs), and price is set at the equilibrium between supply and demand at any instant in time. Various fundamental theorists have proposed that markets are efficient and rational, but technicians believe that humans are often irrational and emotional and that they tend to behave similarly in similar circumstances.

Although fundamental data are key inputs into the determination of value, these data are analyzed by humans, who may be driven, at least partially, by factors other than rational factors. Human behavior is often erratic and driven by emotion in many aspects of one’s life, so technicians conclude that it is unreasonable to believe that investing is the one exception where humans always behave rationally. Technicians believe that market trends and patterns reflect this irrational human behavior. Thus, technical analysis is the study of market trends or patterns. And technicians believe
the trends and patterns tend to repeat themselves and are, therefore, somewhat predictable. So, technicians rely on recognition of patterns that have occurred in the past in an attempt to project future patterns of security prices.

Another tenet of technical analysis is that the market reflects the collective knowledge and sentiment of many varied participants and the amount of buying and selling activity in a particular security. In a freely traded market, only those market participants who actually buy or sell a security have an impact on price. And the greater the volume of a participant’s trades, the more impact that market participant will have on price. Those with the best information and most conviction have more say in setting prices than others because the informed traders trade higher volumes.
To make use of their information, however, they must trade. Technical analysis relies on knowledgeable market participants putting this knowledge to work by trading in the market, thereby influencing prices and volume. Without trading, the information is not captured in the charts.

Trades determine volume and price. The impact occurs instantaneously and frequently anticipates fundamental developments correctly. So, by studying market technical data—price and volume trends—the technician is seeking to understand investor sentiment. The technician is benefiting from the wide range of knowledge of market participants and the collective conclusion of market participants about a security. In contrast, the fundamental analyst must wait for the release of financial statements to conduct financial statement analysis, so a time lag occurs between the
market’s activities and the analyst’s conclusions.

Charles Dow, creator in 1896 of what is now known as the Dow Jones Industrial Average, described the collective action of participants in the markets as follows:

The market reflects all the jobber knows about the condition of the textile trade; all the banker knows about the money market; all that the best- informed president knows of his own business, together with his knowledge of all other businesses; it sees the general condition of transportation in a way that the president of no single railroad can ever see; it is better informed on crops than the farmer or even the Department of Agriculture. In fact, the market reduces to a bloodless verdict all knowledge bearing on finance, both domestic and foreign.

A similar notion was expressed by George A. Akerlof and Robert J. Shiller:

To understand how economies work and how we can manage them and prosper, we must pay attention to the thought patterns that animate people’s ideas and feelings, their animal spirits. We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature.

Market participants use many inputs and analytical tools before trading. Fundamental analysis is a key input in determining security prices, but it is not the only one. Technical analysts believe that emotions play a role. Investors with a favorable fundamental view may nonetheless sell a financial instrument for other reasons, including pessimistic investor sentiment, margin calls, and requirements for their capital—for example, to pay for a child’s college tuition. Technicians do not care why market participants are buying or selling, just that they are doing so.

Some financial instruments have an associated income stream that contributes to the security’s intrinsic value. Bonds have regular coupon payments, and equity shares may have underlying cash flows or dividend streams. A fundamental analyst can adjust these cash flows for risk and use standard time value of money techniques to determine a present value. Other assets, such as a bushel of wheat, gallon of crude oil, or ounce of silver, do not have underlying financial statements or an income stream, so valuation models cannot be used to derive their fundamental intrinsic values. For these assets, technical analysis is the only form of analysis possible. So, whereas fundamental analysis is widely used in the analysis of fixed-income and equity securities, technical analysis is widely used in the analysis of commodities, currencies, and futures.

Market participants attempt to anticipate economic developments and enter into trades to profit from them. Technicians believe that security price movements occur before fundamental developments unfold—certainly before they are reported. This belief is reflected in the fact that stock prices are one of the 12 components of the National Bureau of Economic Research’s Index of Leading Economic Indicators. A key tenet of technical analysis is that the equity market moves roughly six months ahead of inflection points in the broad economy.

Technical and Fundamental Analysis

Technical analysis and fundamental analysis are both useful and valid, but they approach the market in different ways. Technicians focus solely on analyzing markets and the trading of financial instruments. Fundamental analysis is a much wider field, encompassing financial and economic analysis as well as analysis of societal and political trends. Technicians analyze the result of this extensive fundamental analysis in terms of how it affects market prices. A technician’s analysis is derived solely from price and volume data, whereas a fundamental equity analyst analyzes a company and incorporates data that are external to the market and then uses this analysis to predict security price movements. As the quotation from Dow in illustrates, technical analysis assumes that all of the factors considered by a fundamental analyst are reflected in the price of a financial instrument through buying and selling activity.

A key distinction between technical analysis and fundamental analysis is that the technician has more concrete data, primarily price and volume data, to work with. The financial statements analyzed by fundamental analysts are not objective data but are the result of numerous estimates and assumptions that have been added together to arrive at the line items in the financial statements. Even the cash line on a balance sheet is subject to corporate management’s opinion about which securities are liquid enough to be considered “cash.” This opinion must be agreed to by auditors and, in many countries, regulators (who sometimes differ with the auditors). Financial statements are subject to restatements because of such issues as changes in accounting assumptions and even fraud. But the price and volume data used in technical analysis are objective. When the data become subject to analysis, however, both types of analysis become subjective because judgment is exercised when a technician analyzes a price chart and when a fundamental analyst analyzes an income statement.

Fundamental analysis can be considered to be the more theoretical approach because it seeks to determine the underlying long-term (or intrinsic) value of a security. Technical analysis can be considered to be the more practical because a technician studies the markets and financial instruments as they exist, even if trading activity appears, at times, to be irrational. Technicians seek to project the level at which a financial instrument will trade, whereas fundamental analysts seek to predict where it should trade.

Being a fundamental analyst can be lonely if the analyst is the first to arrive at a fundamental conclusion, even though it is correct, because deviations from intrinsic value can persist for long periods. The reason these deviations may persist is that it takes buying activity to raise (or lower) the price of a security in a freely traded market.

A drawback of technical analysis is that technicians are limited to studying market movements and do not use other predictive analytical methods, such as interviewing the customers of a subject company, to determine future demand for a company’s products. Technicians study market trends and are mainly concerned with a security’s
price trend: Is the security trading up, down, or sideways? Trends are driven by collective investor psychology, however, and can change without warning.

Additionally, it can take some time for a trend to become evident. Thus, technicians may make wrong calls and have to change their opinions. Technicians are better at identifying market moves after the moves are already underway.

Moreover, trends and patterns must be in place for some time before they are recognizable, so a key shortcoming of technical analysis is that it can be late in identifying changes in trends or patterns. This shortcoming mirrors a key shortcoming of fundamental analysis in that securities often overshoot fundamental fair values in an uptrend and undershoot fundamental fair values in a downtrend. Strictly relying on price targets obtained by fundamental analysis can lead to closing profitable investment positions too early because investors may irrationally bid securities prices well above or well below intrinsic value.

Fundamental analysis is a younger field than technical analysis because reliable fundamental data are a relatively new phenomenon. In contrast, the first recorded use of technical analysis was in Japan in the 1700s, where it was used to analyze trading in the rice market. The Japanese developed a detailed field of technical analysis with their own chart design and patterns. These tools were translated and widely understood outside Japan only in the 1980s.

Western use of technical analysis was pioneered by Dow, who was also the first editor of the Wall Street Journal, in the 1890s. At the time, publicly traded companies were under no requirement to release their financial information even to shareholders, and insider trading was common and legal. Dow created the Dow Jones Industrial Average and the Dow Jones Railroad Average (now the Transportation Average) as a proxy to gauge the health of the economy, because fundamental data were not available. By his logic, if industrial stocks were doing well, industrial companies themselves must be doing well and if railroad stocks were doing well, railroad companies must be doing well. And if both manufacturers and the companies that transported goods to market were prospering, the economy as a whole must be prospering.

Not until the Securities Exchange Act of 1934 were public companies in the United States required to regularly file financial statements that were available to the public. In that year, Benjamin Graham published his seminal work, Security Analysis, and three years later, he and several others founded one of the first societies devoted to fundamental analysis, the New York Society of Security Analysts. Fundamental analysis quickly overtook technical analysis in terms of acceptance by practitioners, regulators, and academics.

Acceptance of technical analysis by practitioners was revived in the 1970s with the creation of the Market Technicians Association in New York and the International Federation of Technical Analysts a few years later. Only in the last decade, however, has the field started to achieve widespread acceptance by regulators and academics. An important impediment to acceptance by academics is the difficulty of capturing the subjectivity involved in technical analysis. The human brain can recognize, analyze, and interpret technical information that is difficult for statistical computer models to recognize and test.

Although technical analysis can be applied to any freely traded security, it does have its limits. In markets that are subject to large outside manipulation, the application of technical analysis is limited. For example, the central banks of many countries intervene in their currency markets from time to time to maintain exchange rate stability. Interestingly, traders claim to have been able to successfully predict interventions in some countries, especially those where the central bank is itself using technical analysis. Technical analysis is also limited in illiquid markets, where even modestly sized trades can have an inordinate impact on prices. For example, in considering a thinly traded American Depositary Receipt (ADR), analyzing the more heavily traded local security frequently yields a better analysis.4 Another example of when technical analysis may give an incorrect reading is in the case of a company that has declared bankruptcy and announced that its shares will have zero value in a restructuring. A positive technical trend may appear in such cases as investors who hold short positions buy shares to close out their positions.

A good example of when technical analysis is a superior tool to fundamental analysis is in the case of securities fraud, such as occurred at Enron Corporation and WorldCom. These companies were issuing fraudulent financial statements, but many fundamental analysts continued to hold favorable views of the companies’ equity securities even as the share prices declined. Simultaneously, a small group of investors came to the opposite view and expressed this view through high-volume sales of the securities. The result was clearly negative chart patterns that could then be discerned by technical analysis.

On that note I will share with you a paragraph from a book I highly recommend called “Technical Analysis of Stock Trends” by John Magee and Robert D. Edwards making the same case, favoring technical approach:

The technical student argues thus: it is futile to assign an intrinsic value to a stock certificate. One share of United States Steel, for example, was worth $261 in the early fall of 1929, but you could buy it for only $22 in June of 1932! By March 1937, it was selling for $126 and just 1 year later for $38. In May of 1946, it had climbed back up to $97, and 10 months later, in 1947, had dropped below $70, although the company’s earnings on this last date were reputed to be nearing an all-time high and interest rates in general were still near an all-time low. The book value of this share of U.S. Steel, according to the corporation’s balance sheet, was about $204 in 1929 (end of the year); $187 in 1932; $151 in 1937; $117 in 1938, and $142 in 1946. This sort of thing, this wide divergence between presumed value and actual price, is not the exception; it is the rule. It is going on all the time. The fact is that the real value of a share of U.S. Steel common is determined at any given time solely, definitely, and inexorably by supply and demand, which are accurately reflected in the transactions consummated on the floor of the New York Stock Exchange. Of course, the statistics which the fundamentalists study play a part in the supply–demand equation — that is freely admitted. But there are many other factors affecting it. The market price reflects not only the differing value opinions of many orthodox security appraisers, but also all the hopes and fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, as well as their needs and their resources — in total, factors which defy analysis and for which no statistics are obtainable, but which are nevertheless all synthesized, weighed, and finally expressed in the one precise figure at which a buyer and a seller get together and make a deal (through their agents, their respective stock brokers). This is the only figure that counts.

Conclusion

I am going to take a step back talk in layman’s terms. Cryptos are a mixture between a currency and a share of the stock. Fundamental analysis is great for evaluating an intrinsic value, but so far I haven’t seen anyone successfully asses an intrinsic value of Bitcoin, let alone hundreds of ICO’s. This price of a coin is solely determined by supply and demand. That’s why learning Technical Analysis is key to success in crypto in my mind.

Endnote: Do not mix me favouring TA with recommending trading cryptos. I will express my views on a seperate post regarding that matter, but just a quick disclaimer. Trading is impossible for now as there aren’t any good opportunities to short sell the market (selling short allows you to make money while prices are falling). Instead use TA to calculate entry points, risk/reward ratio and take profit levels on a long-term base.

SUMMARY

■ Technical analysis is a form of security analysis that uses price and volume market data, often graphically displayed.
■ Technical analysis can be used for any freely traded security in the global market and is used on a wide range of financial instruments, such as equities, bonds, commodity futures, and currency futures.
■ Technical analysis is the study of market trends or patterns and relies on recognition of patterns that have worked in the past in an attempt to predict future security prices. Technicians believe that market trends and patterns repeat themselves and are somewhat predictable because human behavior tends to repeat itself and is somewhat predictable.
■ Another tenet of technical analysis is that the market brings together the collective wisdom of multiple participants, weights it according to the size of the trades they make, and allows analysts to understand this collective sentiment. Technical analysis relies on knowledgeable market participants putting this knowledge to work in the market and thereby influencing prices and volume.
■ Technical analysis and fundamental analysis are equally useful and valid, but they approach the market in different ways. Technical analysis focuses solely on analyzing markets and the trading of financial instruments, whereas fundamental analysis is a much wider ranging field encompassing financial and economic analysis as well as analysis of societal and political trends.
■ Technical analysis relies primarily on information gathered from market participants that is expressed through the interaction of price and volume. Fundamental analysis relies on information that is external to the market (e.g., economic data, company financial information) in an attempt to evaluate a security’s value relative to its current price.
■ The usefulness of technical analysis is diminished by any constraints on the
security being freely traded, by large outside manipulation of the market, and in
illiquid markets.

TEST

1 Technical analysis relies most importantly on:

A price and volume data.
B accurate financial statements.
C fundamental analysis to confirm conclusions.

2 Which of the following is not an assumption of technical analysis?

A Security markets are efficient.
B The security under analysis is freely traded.
C Market trends and patterns tend to repeat themselves.

3 Drawbacks of technical analysis include which of the following?

A It identifies changes in trends only after the fact.
B Deviations from intrinsic value can persist for long periods.
C It usually requires detailed knowledge of the financial instrument under
analysis.

4 Why is technical analysis especially useful in the analysis of commodities and

currencies?
A Valuation models cannot be used to determine fundamental intrinsic value
for these securities.
B Government regulators are more likely to intervene in these markets.
C These types of securities display clearer trends than equities and bonds do.

End of Part 1
In the following post we will be covering Technical Analysis tools. PART 2 will be dedicated to Charts - types, japanese candlestick chart, how candles are formed and how to read price action.

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