Technical analysis (TA), often referred to as charting, is a type of analysis that aims to predict future market behavior based on previous price movement patterns and volume data.
The TA approach is widely applied to the integral components of digital currency trading in the cryptocurrency market. Unlike fundamental analysis (FA), which considers many factors to determine the fair price of an asset, TA strictly focuses on the price history of an asset to determine its future price.
Therefore, the TA indicator is usually used as a tool to check asset volume data for price fluctuations. Many traders apply it to identify profitable trading trends and opportunities.
How does technical analysis work?
Basically, TA is the study of the current and past prices of assets. The main assumption underlying this technical analysis is that price fluctuations of an asset generally develop into identifiable trends from time to time.
Simply put, TA is an analysis of the forces of market supply and demand as a representation of overall market sentiment. In other words, the price of an asset reflects the opposing buying and selling forces. This strength is closely related to the emotions of traders and investors (usually in the form of fear and greed).
TA is considered more effective and appropriate when applied to markets operating under normal conditions with high volume and high liquidity. High volume markets are safer from the risk of price manipulation and abnormal external influences, which can create false signals and render TA useless.
Traders can use various charting tools, known as indicators, to check for profitable opportunities. These technical analysis indicators can help traders identify existing trends, as well as provide information about trends that may emerge in the future.
Frequently used TA indicators
To reduce the risk of errors, some traders use several indicators at once to determine market trends. Here are some technical analysis indicators that are often used by traders.
Simple moving averages (SMA)
Among the many technical analysis indicators, simple moving averages (SMA) are one of the most widely used examples. As the name implies, the SMA indicator is calculated based on the closing price of an asset at a certain time.
There is now an exponential moving average (EMA), a recent version of the SMA that has been modified so that it places more emphasis on prices in the nearest future than on prices that are more distant.
Relative strength index (RSI)
Another commonly used indicator is part of a class of indicators known as oscillators. Unlike SMA, which only tracks price changes over time, oscillators apply a mathematical formula to record price changes. Later the formula produces data in a predetermined range. Usually the range ranges from 0 to 100.
Bollinger Bands (BB)
The Bollinger Bands (BB) indicator is another type of oscillator that is quite popular among traders. The BB indicator itself consists of two lateral bands that flow around the SMA indicator line. It is used to measure market volatility as well as identify potential overbought and oversold market conditions.
Moving Average Convergence Divergence (MACD)
Another popular indicator in technical analysis is the Moving Average Convergence Divergence (MACD). The MACD is generated by subtracting two EMAs to create a main line (the MACD line).
Then, the first line is used to generate another EMA, which creates the second line (known as the signal line). Additionally, there is the MACD histogram, which is calculated based on the difference between the two lines.
In addition to identifying general trends, the TA indicator can also provide information about potential buy or sell signals. These signals can be generated through certain events that occur on the indicator chart.
For example, when the RSI produces a value of 70 or more. It shows that the market is operating in an overbought condition. Similarly, when the RSI drops to 30 or less, it is considered a signal of an oversold market condition.
It should be noted that the trading signals provided by technical analysis are not always accurate. The TA indicator generates a significant amount of noise, which can lead to signal errors, especially in the cryptocurrency market.
Critics of technical analysis consider it to be an unreliable and controversial method. Technical analysis is often referred to as a “self-fulfilling prophecy” because events that were predicted based on TA often happen only because many traders and investors believed they would.
Critics argue that if many traders and investors rely on the same type of indicator, such as support or resistance lines. The chances of that indicator working accurately will increase, which can lead to market inefficiencies.
On the other hand, many proponents of TA argue that every chartist has a unique way of analyzing charts and using the many available indicators. Therefore, it is almost impossible for traders to use the same specific strategy, and there is room for interpretation and customization of TA tools to fit their own trading style
Fundamental analysis vs technical analysis
The main premise of TA is that market prices reflect all the fundamental factors associated with a particular asset. However, unlike the TA approach, which mainly focuses on historical price and volume data (market charts), fundamental analysis (FA) adopts a broader strategy of investigating qualitative factors.
FA is a method used to estimate the intrinsic value of a company, business, or asset based on various micro- and macroeconomic conditions, such as management and company reputation, market competition, growth rate, and industry health. This fundamental analysis considers that the future performance of an asset depends on more than historical data.
It can be concluded that, unlike TA, which is often used as a predictive tool for prices and market behavior, FA is a method for determining whether an asset is overvalued or not based on its context and potential. While technical analysis is mostly used by short-term traders. Fundamental analysis tends to be preferred by fund managers and long-term investors.
One advantage of technical analysis is its dependence on quantitative data. It provides an objective framework for investigating price history. Without some of the predictions that come from a more qualitative approach to fundamental analysis.
However, despite dealing with empirical data, TA is influenced by personal subjectivity and bias. For example, a trader with strong preconceived notions about an asset may manipulate their TA tool to support their biases. In some cases, this happens unconsciously. Additionally, technical analysis can fail during periods when the market shows no clear pattern or trend.