How to read crypto charts: Technical analysis for beginners

The world of digital assets is known for its wild price swings, but if you look closely, you might notice that cryptocurrency prices sometimes follow recognizable patterns. 

By analyzing historical data in technical charts, savvy traders can sometimes identify trends and predict potential price movements. However, while technical analysis provides valuable insights, it’s no metaphorical magic crystal ball and cannot foresee all market events.

In this guide, we’ll explain how to read crypto charts, discuss the benefits and risks of using technical analysis, and highlight key factors to consider before making a trade.

The importance of understanding cryptocurrency charts

Traders looking to maximize gains and minimize losses often start by learning how to interpret past price movements and trading volume in crypto charts, which helps predict future market changes. This strategy, known as technical analysis, can lead to more profitable trading decisions because it allows investors to anticipate bullish (upward) and bearish (downward) trends over time. By studying statistical market patterns, traders gain a deeper understanding of a cryptocurrency’s supply-and-demand dynamics, helping to indicate the best moments to buy or sell.

A 101 on technical analysis

Charles Dow, the founder of The Wall Street Journal and creator of Dow Theory, introduced the theory of technical analysis method in the late 1800s, more than a century before the advent of digital assets. He initially developed it to identify trends in the Dow Jones Industrial Average (DJIA), but the principles of Dow Theory now apply to all tradable assets, including cryptocurrencies. 

Dow identified several key principles of technical analysis that continue to guide traders today:

1. Markets have three major phases: Dow believed in a three-phase pattern – accumulation, markup, and distribution – that reflects observable shifts in an asset's supply and demand. 
2. Markets discount all news: Dow emphasized the impact of news on prices, whether good or bad. He stressed the importance of incorporating the news cycle into technical analyses.
3. Market averages must confirm each other: Similar markets must experience similar changes before a trend is taken seriously. For instance, if Bitcoin is moving up or down, Bitcoin mining stocks would confirm the trend by moving accordingly.
4. Volume confirms trends: Dow identified price trends in the stock market and believed that the direction and persistence of market prices could be observed and used to predict future movements. He famously used an asset's trading volume to confirm trends observed in price movements.
5. Trends exist until they don't: Trends are not guaranteed to continue indefinitely. Technical analysis provides traders with tools to identify reversals in current trends.

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Analyzing crypto charts: Key components

Be it a crypto chart or a treasure map, what good is it if you don’t know how to read it? Here’s a breakdown of the fundamental concepts in technical analysis:

• Trading pair: A crypto chart often represents an asset's price against another currency, such as BTC/USD (Bitcoin priced in U.S. dollars) or BTC/ETH (Bitcoin priced in Ethereum). Understanding the trading pair is essential for contextualizing the asset's value.
• Current price: Displayed prominently on the chart, this reflects the most recent transaction price within the selected time frame, providing an immediate snapshot of the asset's market value.
• High/low prices: This highlights the highest and lowest prices a cryptocurrency has reached during the specified period. These figures indicate the asset's volatility and help identify potential entry and exit points.
• 24-hour volume: This metric shows the total amount of the asset traded within the last 24 hours. High trading volume can confirm the strength of observed trends, providing deeper insights into market activity. Volume is often displayed as bars below the price chart, with significant volume changes offering clues about market sentiment.
• Price chart: This is the main graphical representation on the chart, illustrating the token’s price changes over a specific period. It helps traders identify price trends and patterns, such as support and resistance levels.
• Market capitalization: The total valuation of a cryptocurrency, calculated by multiplying the circulating supply by its current price. For instance, Bitcoin (BTC) has seen its market cap exceed $1 trillion at various points, signifying its dominance in the market.
• Relative strength index (RSI): An important momentum indicator, the RSI assigns a value between 0 and 100 to gauge an asset's strength or weakness. Typically, an RSI below 30 indicates the asset is oversold, while an RSI above 70 suggests it is overbought, both of which can signal potential price reversals.
• Support and resistance: These terms refer to key price levels where an asset typically reverses direction. Support represents the lower "floor" where the price tends to stabilize, while resistance is the upper "ceiling" where it faces selling pressure. Recognizing these levels is crucial for planning entry and exit strategies.
• Price volume and movements: Monitoring price fluctuations alongside volume data helps traders assess the significance of price changes. For example, a price increase accompanied by high volume may indicate strong market interest, whereas a price drop with low volume might be less concerning.
• Simple moving average (SMA): The SMA smooths out price data over a specific period to provide a clearer view of trends. For example, if Ethereum (ETH) has prices of $3,500, $3,400, and $3,600 over three days, the SMA averages these prices to offer a single data point that simplifies trend analysis. Traders often use the SMA along with other indicators, such as the exponential moving average (EMA), to enhance their analysis.

What are candlestick charts?

Candlestick charts are a specific type of technical analysis that traders use to understand opening, closing, highest, and lowest prices during a trading period. Each "candlestick" on the chart represents trading activity over a specified period, using colors – typically red and green – to indicate whether prices have risen or fallen. 

The main body of the candlestick shows the opening and closing prices, while the thin extensions, or wicks, highlight the highest and lowest trades. Traders often analyze patterns within these charts, such as "doji," "hammer," or "engulfing" formations, which can signal potential market trends, reversals, or continuations.

Technical analysis benefits, risks, and alternatives

For traders who use chart patterns and indicators to guide their decisions, understanding their range of benefits and risks is a must. Here’s an overview of the key advantages, potential pitfalls, and some alternative strategies to consider:

Benefits

• Market trend analysis: Traders can capitalize on market momentum and price trends to maximize gains. By analyzing historical data, they can better predict future price movements.
• Indicators for decision-making: Technical analysis offers a variety of tools that help traders identify potential market trends and make informed trading decisions. While no indicator is foolproof, using multiple indicators together can improve reliability.
• Identifying entry and exit points: Technical analysis traders time their trades by pinpointing optimal entry and exit points, which is crucial for maximizing potential returns.
• Diverse analytical choices: Traders can choose from various techniques and indicators, such as moving averages and RSI, allowing them to tailor their strategies to suit their specific trading style.

Risks

• Overlooking fundamentals: Relying solely on technical analysis can lead to misjudgments since it doesn't account for a token's underlying value or fundamentals.
• Bias in interpretation: Personal bias can influence how traders interpret data, potentially leading to decisions based on emotion rather than objective analysis.
• False signals: Not every trend or pattern identified will materialize, and false signals can lead to losses. Traders often use multiple indicators to confirm signals before acting.
• Subjectivity: The interpretation of technical analysis can vary from trader to trader, with the same data leading to different conclusions, which can affect decision-making.

Alternatives to technical analysis

• Dollar-cost averaging (DCA): This strategy involves regularly investing a fixed amount in an asset, regardless of market conditions. By spreading out purchases, traders can reduce the impact of volatility over time.
• “Hold on for dear life” (HODL): The HODL approach involves holding onto crypto assets long-term, regardless of short-term market fluctuations, based on the belief in the asset’s future value.

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.