by Jake Wengroff
Cryptocurrency investors wishing to make more informed decisions about which assets to buy, sell or hold can benefit from technical analysis in order to understand market trends and identify opportunities. Technical analysis refers to the study of statistical trends over time in order to better understand how an asset’s performance can predict future price changes. Past trading activity — signaling supply and demand of an asset—including volume and pricing can be helpful in predicting future price movements. While this strategy has been used for quite some time for other asset classes, especially those with significant historical trading data, technical analysis can absolutely be applied to the performance of cryptocurrencies, even though the crypto markets are much younger.
Technical analysis was first introduced by Charles Dow, the founder and editor of the Wall Street Journal and the co-founder of Dow Jones & Company. Dow’s ideas were written over a series of editorials published in the newspaper, and continuing after his death, were compiled to create what is now known as the Dow theory, which is the basis of technical analysis and reading cryptocurrency charts. Technical analysis works when all known information about an asset is shared publicly and when the market has acknowledged this information into the asset’s price. With all information known and incorporated, the asset is said to be fairly valued. This is a general philosophy applying to all publicly traded asset classes, including crypto.
How to Read Crypto Charts: The Dow Theory
There are six main components to the Dow theory:
1. The Market and Efficient Markets Hypothesis
The Dow theory operates on the efficient markets hypothesis (EMH), which states that asset prices incorporate all available information, as cited above, leading to fair valuations. While not every investor knows everything there is to know about the people or organization behind an asset, such as competitive advantage or product roadmaps, all of these factors are priced into the market.
2. Only Three Types of Market Trends
According to Investopedia, markets experience three types of trends. The first, or primary, trend lasts a year or more, and is usually characterized broadly as either a bull or bear market. Within these broader trends, markets experience smaller, secondary trends, often working against the primary trend, such as a pullback within a bull market or a rally within a bear market; these secondary trends last much shorter than a primary trend, lasting from only three weeks to three months. Finally, there are minor trends lasting less than three weeks, which are largely just noise.
3. Primary Trends Have Three Phases
According to the Dow theory, the trends mentioned above each go through three phases. In a bull market, these are the accumulation phase, the public participation (or big move) phase, and the excess phase. In a bear market, the phases are known as the distribution phase, the public participation phase and the panic (or despair) phase.
4. Indices Must Confirm Each Other
In order for a trend to be established by the market, Dow hypothesized that indices or market averages must confirm each other. This means that the signals that occur on one index must match or correspond with the signals on the other. If one index, such as the Dow Jones Industrial Average, is confirming a new primary uptrend, but another index remains in a primary downward trend, traders should not assume that a new trend has begun. This correlation adds an extra confirmation, prevents a false positive and removes distraction.
5. Volume Must Confirm the Trend
As another validation, Dow hypothesized that trading volume should increase if the price is moving in the direction of the primary trend and decrease if it is moving against it. Low trading volume signals a weakness in the trend. For example, in a bull market or environment of rising stock prices, trading volume should increase along with the price.
6. Trends Persist until a Clear Reversal Occurs
However, it is important to note that reversals in primary trends can be confused with secondary trends. “It is difficult to determine whether an upswing in a bear market is a reversal or a short-lived rally to be followed by still lower lows, and the Dow theory advocates caution, insisting that a possible reversal be confirmed,” adds Investopedia.
Reading Candlestick Charts
Candlestick charts can be extra helpful in understanding price movements, as they show price movements within a specified time frame and the “candlesticks” show whether the price movement was positive or negative. Candlestick charts can be adjusted based on the trader’s chosen time period, which often reflects a particular trading style or strategy. A candlestick is essentially made up of a “body” and “wicks.” The body of each candlestick represents its opening and closing prices; the top wick represents how high the price reached during that time frame, and the bottom wick represents the lowest price it reached. The colors used in candlestick charts are helpful to easily identify price trends within the chosen time frame: green or red. Green candles show the price went up over the period while red candles show that the price dropped.
Protect Your Crypto Assets as You Trade
As crypto investors seek market opportunities via different trading platforms, they need peace of mind that their assets are safe. While the blockchain cannot be hacked, the applications, including the wallets, exchanges and platforms, built upon them can be vulnerable to misuse. TransitNet is developing a solution that the market needs: a third-party title registry that serves as proof of ownership of crypto assets. It’s the industry’s first, and it will add a layer of protection for investors, regardless of how they are investing their crypto. Join the forefront of the new crypto infrastructure with TransitNet.
Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, he covers such topics as security, mobility, e-commerce and the Internet of Things.
Corporate Finance Institute (CFI) – Technical Analysis – A Beginner’s Guide
Analyzing Data – History of Technical Analysis
Investopedia – Dow Theory
Coinbase – What is a bull or bear market?