Technical analysis is a set of tools employed to evaluate the existing price trend of Bitcoin and identify the optimal market entry and exit points.
At the core of Bitcoin technical analysis are chart patterns and technical indicators.
Chart patterns are formations that appear repeatedly on the price chart. The analysis of chart patterns helps to identify the probable direction of future price movements.
Technical indicators are essentially mathematical formulas and algorithms that use the market price and volume data as input variables to transform it into a meaningful price forecast.
Let’s begin our journey into technical analysis from learning the primary tool of every trader - the price chart.
Traders use charts to identify trends and patterns in prices over time. We primarily use charts with market price and volume data presented on the vertical axis and time presented on the horizontal axis.
The timeframe chosen (monthly, weekly, daily, or intraday periods from M1 to H4) reflects the trading horizon that the trader is using when making price forecasts and trading decisions. A trader will typically start by observing longer-term trends on monthly and weekly charts, then look at recent activity on the daily chart, and then identify the best market entry and exit points by looking at intraday charts (M1-H4).
If prices have changed exponentially (e.g., the Bitcoin price over the past 5 years), a trader may choose to draw charts on a logarithmic scale instead of the usual linear scale.
Line charts are the simplest technical analysis charts. They show-closing prices for each period as a continuous line. Here is an example of a line chart for BTC/USD:
Candlestick charts display a box for each period bounded by the opening and closing prices. The upper vertical line represents the highest price over the period, and the lower one represents the lowest price over the same period. If the box is green, then the closing price is higher than the opening price. If it is red, then the closing price is lower than the opening price. Candlestick charts make patterns easier to recognize.
Bar charts show a vertical line for each period, reflecting the high and low prices for each trading period, as well as the closing price indicated as a dash on the right side of the line and the opening price indicated as a dash on the left side.
The Basics Of Trend Analysis
One of the most important concepts of technical analysis is trend analysis. The primary assumption underlying trend analysis is that market prices tend to move in the same direction for some time.
A trading instrument, such as a BTC/USD (Bitcoin vs. U.S. Dollar), can be considered to be in an upward trend, a downward trend, or a flat (sideways) trend.
Traders who are able to identify price trends right at the beginning get the opportunity to open a position in the direction of the trend and earn a profit from the difference in prices. Therefore, the trader’s goal is to BUY when an asset is in an upward trend and to SELL when an asset is in a downward trend.
The prices of financial assets are not in a trend all the time. When the price is moving sideways, it is better to abstain from trading, because it becomes difficult to make forecasts by using technical analysis. It is much better to trade, and the forecasts tend to be more accurate when the price is either in a strong upward trend or a downward trend.
How To Identify An Upwards Trend?
An uptrend is when the price goes to higher highs and higher lows. For example, as Bitcoin price moves up, each subsequent new high should be higher than the prior high, and, whenever there is a retracement downwards, each subsequent new low should be higher than the previous low. There are many ways to identify an upward trend, both visually or using technical indicators.
A trader can simply draw an uptrend line connecting the lows of the price chart. When a price touches this trendline, it is expected to bounce back up. In contrast, a price drop below the trendline may indicate a trend reversal and a further decline in the price. An example of an uptrend line is presented below:
A trader can also apply a trend technical indicator to the chart to identify the direction of the trend, such as a simple moving average. We’ll discuss the mechanics of chart patterns and technical indicators in the next paragraphs.
Overall, when the market is trending upwards, the forces of demand exceed supply on the market, which leads to price increases in the first place. In practice, this means that traders are willing to pay higher and higher prices over time because they expect the price to go even higher in the future compared to where it is now.
The following chart provides an example of a rising Bitcoin price, reflecting a strong upward trend.
When the Bitcoin market is trending upwards, this means that there is a strong demand for Bitcoin, probably driven by the traders believing the fair value of Bitcoin is higher than its current market price, and the market price is expected to appreciate in future.
How To Identify A Downwards Trend?
A downtrend is when the price goes to lower lows and lower highs. For example, as Bitcoin price moves down, each subsequent new low is lower than the prior low, and, whenever there is a retracement upwards, each subsequent new high is lower than the previous high.
Similar to an uptrend, traders can use chart patterns and technical indicators to identify a downward trend. When the market is trending downwards, supply is overwhelming demand on the market and, as a result, traders are willing to accept lower and lower prices to close long positions or enter new short positions.
The following chart provides an example of a declining Tesla share price, reflecting a strong downward trend.
When Tesla’s share price is trending downwards, as shown in the example above, it means that the overall market sentiment is deteriorating and traders expect the price to continue declining, thus inducing them to sell now.
Short-term, medium-term and long-term trends
The ability to differentiate between different durations of price trends and use multiple timeframes in trading is of great importance for traders. Thus, traders differentiate between the short-term, medium-term and long-term trends.
Short-term price trends tend to persist over a few days and are primarily used by active intraday traders. Active traders strive to spot the core intraday trend by eliminating market noise and may open multiple positions within a single day. In contrast, long-term investors are not interested in intraday volatility and are more focused on identifying longer-term trends. The best chart timeframe for trading short-term trends is from M1 (one-minute timeframe) to M15 (fifteen-minute TF).
Medium-term trends usually encompass periods from a couple of weeks to six months. Usually, they are used by both active traders and long-term investors in trend analysis to confirm their assumptions. Investors use medium-term trends to identify the best entry and exit points within the overall long-term trend cycle. The best chart timeframe for trading medium-term trends is from H1 (one-hour TF) to D1 (one-day TF).
And, finally, long-term trends encompass periods from half a year to multiple years. Many of the long-term investors employ a “buy-and-hold” trading strategy, have a longer-term investment horizon and set target prices far into the future.
Breakout From A Downtrend & An Uptrend
Drawing a trendline on a chart can help to identify whether a trend is continuing or reversing.
In an uptrend, a trendline connects the increasing lows in price. In a downtrend, the trendline connects the decreasing highs in price.
When the price crosses the trendline by what the trader considers a significant amount (usually, 1-2% of the price), a breakout from a downtrend or a breakdown from an uptrend is said to occur.
Either a breakout or a breakdown may signal the end of the previous trend (i.e. trend reversal).
The following chart provides an example of several breakouts upward from a downtrend trend (indicated by red linear channels).
Support and resistance
Support and resistance are two concepts closely related to trend analysis.
Support is defined as a price level at which the power of buyers is sufficient to stop the decline in price and reverse it upwards.
Resistance is a price level at which the power of sellers is sufficient to stop the rise in price and reverse it downwards.
The power of buyers and sellers is measured by trade volume. Thus, when the price is approaching a support level, the volume of buy orders at that level begins to exceed the volume of sell orders and the price reverses upwards.
Similarly, when the price is approaching a resistance level, the volume of buy orders at that level begins to exceed the volume of sell orders and the price reverses upwards.
Support and resistance levels frequently appear at psychologically important prices such as round-number prices or historical highs and lows. The psychology behind this is that traders often place limit orders as well as stop-loss and take-profit orders at round numbers and near the previous significant lows and highs.
Support And Resistance - Example 1
Let’s review an actual trade example (the link) involving the analysis of support and resistance levels to make a trading decision. Here is the analysis of the Bitcoin chart published on June 13, 2019:
In this Bitcoin chart analysis, the support at $7,500 has been tested three times by the sellers over the past week (at a time of the analysis) and wasn't broken. This price behavior suggested that the market was unlikely to move further downwards and reinforced the upward trend signal.
As we can see, that conclusion proved to be accurate and the market continued to move upwards.
Support And Resistance - Example 2
Let’s review another example (the link) involving the analysis of support and resistance levels to make a trading decision:
In that Bitcoin price analysis, we concluded that there were no reasons for the price to retrace downwards at that point. The price had moved above the previous local high at $9,000, which sent a clear signal that the market intended to move further upwards.
We recommended holding long positions until the price reaches the target at $10,000 - the nearest significant resistance level - at which the bulls were expected to start taking profits, and the market would adjust.
Once again, our analysis was correct and the $10,000 target placed at the next significant resistance level was the right decision.
The Forecasting Power Of Support And Resistance
As you can see from the Bitcoin price chart below, the $9,000 price is a round number and was a significant resistance level at the time of analysis. Another good example of a significant resistance level is the Bitcoin’s all-time high at $20,000, achieved back in 2017, which is also a round number.
An important observation regarding support and resistance lines is the so-called “change in polarity principle”, which means that once the price has broken through the support level by a meaningful amount, it becomes a resistance (and vice versa). On the next chart of Bitcoin, the price of $8,100 is viewed as a resistance level until the price breaks above that level, then $8,100 becomes a support level as prices decline from their new highs.
Overall, when the price comes close to the support level, the traders consider that price to be an attractive opportunity to buy. Conversely, when the price approaches the resistance level, the traders consider that price as an attractive opportunity to sell.
Chart patterns are recognizable formations that appear repeatedly on the price chart. The analysis of chart patterns helps to identify the probable direction of future price movements.
Some patterns tend to appear at the end of trends, while other patterns indicate that a trend is likely to continue. Therefore, all chart patterns are divided into two major types: reversal patterns and continuation patterns.
To extract useful forecasting information from the different chart patterns, the trader needs to clearly see the direction of trend prior to the pattern and be able to accurately recognize the pattern.
Let’s consider the most popular types of reversal patterns and continuation patterns using some real-life examples on the Bitcoin chart.
Continuation patterns suggest a pause in a trend rather than a reversal. The most common and frequently used types of continuation patterns are triangles are trend channels.
Let’s review, how these patterns should be recognized and show some examples of their application in practice.
Triangles form when prices reach lower highs and higher lows over a period of time. Triangles can be symmetrical, ascending, or descending.
Triangles suggest buying and selling pressure have become roughly equal temporarily, but they do not imply a change in direction of the trend. The size of a triangle, or the difference between the two trendlines at the time when the pattern begins to form, can be used to set a price target, assuming the price breaks out of the triangle and the previous trend continues.
Let’s review how triangles work by the example of an ascending triangle.
An ascending triangle is a figure in which the trendline connecting the high prices is horizontal and the trendline connecting the low prices forms an uptrend.
Let’s review an example on the Ethereum price chart (the link):
Before executing that trade, we conducted an advanced technical analysis for Ethereum based on chart patterns.
In that particular case, there were numerous strong signals, suggesting that the uptrend for ETH/USD is active and is going to continue.
As can be seen from the chart, there was an ascending triangle. In this case, this pattern means that market participants have been selling ETH at $145 over the past two weeks (at the time of analysis), always putting a halt to rallies at the same price point, but that buyers were getting more and more bullish and stepping in at increasingly higher prices to halt sell-offs instead of waiting for further price declines.
We know that an ascending triangle typically forms in an uptrend and is a very strong bullish signal.
Importantly, there was another one significant ascending triangle, restricted from above by the resistance at $165. As the triangle has been forming over the past three months, each rally ceased at a higher and higher low price point, suggesting the buying demand was exerting greater price influence than selling demand over the medium-term. That also indicated that the buyers would most likely challenge the $165 resistance once again and, possibly, the price would break through it.
In that particular analysis we stated:
Now we’re expecting Ethereum price to break through and above the $145 resistance, after which we’ll get an uptrend continuation signal. Based on signals from a variety of technical indicators and continuation chart patterns, we believe that Ethereum price will gain momentum over this week and will rise to at least $160.
As expected, the rally continued above the $145 (beyond the triangle), which has given new momentum to ETH/USD over the next week after the analysis was published, and have driven the price above $200.
As you can see, continuation chart patterns are a strong forecasting and analytical tool, when used in a skillful manner.
As a general rule, the longer the triangle pattern persists, the more volatile and sustained the subsequent price movement is likely to be. In the example shown, the price has broken through and above the $165 resistance and surged up by a significant amount, exceeding $200 in a couple of days.
Trend channel patterns come in two forms - ascending channels and descending channels.
For an ascending trend channel, the trendlines forming the channel slope in an upward direction, within which the price is making higher highs and higher lows. An ascending trend channel is a continuation pattern that confirms the upwards trend signal.
Similarly, in the descending trend channel, the trendlines slope in a downward direction, within which the price is making lower lows and lower highs. A descending trend channel is a continuation pattern that confirms the downward trend signal.
Let’s review how trend channels work by the example of an ascending trend channel (the link).
In this analysis called “Corrective Wave in a Bull Market: Watch for these SIGNALS to Buy” we’ve been referring to an ascending trend channel on the daily timeframe of the Bitcoin chart. We built the channel in such a way that the Bitcoin price was perfectly confined within the trendlines of this channel, which allowed us to identify the target price for Bitcoin, implied by the channel, at $11,500. So, we recommended using $11,500 as a take-profit target for long positions.
This forecast proved to be highly accurate, and the price achieved the $11,500 target within a week after that forecast was made. As you can see, in that particular case, a trend channel as a continuation chart pattern was used as a basis for our buy recommendation, and turned out to have a high forecasting power.
Trend Reversal Patterns
Reversal patterns, as the name implies, are used to identify the end of a trend. Reversal patterns occur when a trend approaches a range of prices but fails to continue beyond that range. Evidence that the direction of trend is about to change is certainly important, so reversal patterns are a valuable tool for traders.
A well-known example is a head-and-shoulders pattern. This pattern suggests the demand that has been driving the uptrend is fading, especially if each of the highs in the pattern occurs on declining volume.
Double top and triple top patterns are similar to the head-and-shoulders pattern in that they indicate weakening in the buying pressure that has been driving an uptrend. In both cases, the price reaches a resistance level at which selling pressure appears repeatedly, preventing any further increase in the price.
Moving Average Indicator
A moving average is a price-based indicator that is used to smooth fluctuations (volatility) in a price chart in order to identify the true direction of the price trend.
A moving average is simply the mean value of the last N closing prices. The larger the period of smoothing N, the smoother the moving average line, and the longer-term trend it is expected to indicate.
Traders often use periods that are intuitively reasonable, such as a 30-day moving average reflecting the number of days in a month, or a 180-day moving average reflecting the 6-month period.
Traders often use several moving averages with different smoothing periods to identify and confirm the prevailing price trend. For example, the one could use a fast MA with a 10-day period to identify the short-term trend, and a slow MA with a 90-day period to identify a long-term price trend.
When a fast-moving average crosses above a slow moving average (a “golden cross”), this is often viewed as a signal of an emerging upwards trend and generates a ‘buy' signal.
Conversely, the fast average crossing below the slow average (a “dead cross”) is often viewed as an evidence of the beginning of a downtrend trend, generating a ‘sell’ signal.
Let’s review a real-life example of how MAs can be applied in Bitcoin trading (the link).
In that analysis, we assumed that Bitcoin might achieve $4,500 in a week and recommended to buy it.
We applied two moving averages - both fast and slow - to identify the direction of the trend. So, at the time of analysis, both quick (10-days) and slow (30-days) exponential moving averages were increasing. We concluded that since both EMAs - with short and long periods - were growing and the BTC price was moving above the quick EMA, the appropriate signal was to Buy Bitcoin. As you can see, the signal turned out to be correct.
At its core, MACD is a very powerful indicator, and provides good forecasting accuracy if used accurately.
The MACD stands for the moving average convergence/divergence oscillator. It is constructed by two lines, the MACD line and the signal line.
The MACD line is the difference between two exponentially smoothed moving averages (EMAs) with fast and slow periods. In the example below, we apply 7 and 30 days as inputs.
The Signal line is simply an EMA of the MACD line. In the example below, we apply the 5-days EMA .
The indicator oscillates around zero and has no upper or lower limit.
Traders use the MACD in technical analysis in three ways:
- By analyzing the crossovers of the MACD line and the signal line
- By analyzing whether the MACD is outside its normal range
- By using trend lines on the MACD itself (convergence/divergence).
Let’s review each of these signals in application to the Bitcoin trend, as presented in the following example.
MACD Indicator - Example
Here is an example of the Bitcoin chart where we apply the MACD indicator to forecast the Bitcoin price (the link).
- The MACD line is significantly above zero and is moving up. This is a storing signal indicating that BTC/USD is in an UPTREND. Practically, it means that the Bitcoin’s short-term trend is upwards and is accelerating, as compared to the long-term price trend.
- We can see that on Mar 21 the MACD line has crossed over the signal line from above to below it, which was the result of Bitcoin’s unexpected price decline on that day. Although it indicates that an uptrend has decelerated, as compared to the previous week’s dynamics, it still does not indicate a trend reversal. We should interpret this market dynamics as a normal volatility, but not as a change in trend.
- There were no divergence between the trend in MACD values and the Bitcoin market price. This further confirms that the current trend up is valid.
Bollinger Bands Indicator
Bollinger bands are constructed based on the standard deviation of closing prices over the last n periods. A trader can draw high and low bands a chosen number of standard deviations (typically two). The bands move away from one another when price volatility increases and move closer together when prices are less volatile.
Prices at or above the upper Bollinger band may be viewed as indicating an overbought market, one that is “too high” and likely to decrease in the near term. Likewise, prices at or below the lower Bollinger band may be viewed as indicating an oversold market, one that is “too low” and likely to increase in the near term. A possible trading strategy using BB is to buy when the price is at the lower band or sell when the price is at the upper band.
Here is an example of trade signal generated based on the BB indicator:
There was a strong signal, supporting a buy recommendation: On July 17, 2019, there was a breakout below the lower boundary band, and this breakout implied that the price should retrace upwards and a new bullish wave was likely to commence soon.