5.) Bitcoin Charts & Technical Analysis
The primary vehicle via which all technical analysis is performed is known as the chart. A market chart simply tracks price movements over a specified period of time. Below is an example of the most common type of financial chart, the candlestick chart.
Along the X-axis is the timeframe and along the Y-axis is the price of the security. Each “candlestick” represents a summary of the price action within a given period of time (in this case, a day). The very top and bottom of the line extending through each candlestick are the highs and lows for the given time period, and the body of the candlestick is where prices opened and closed during that time period.
There are many more types of charts that we will get into in future educational material such as Renko, Kagi, and point and figure charts, but we have just enough to move forward for now.
There are a theoretically infinite amount of potential timeframes (TF's) we could analyze for any given market, however there are some common ones that a majority of market participants and technicians use for their analysis: the monthly, weekly, daily, 4-hour (240min), 2-hour (120min), 1-hour (240min), 30 minute, and the 15 minute charts. We occasionally use the 1 and 5 minute charts when markets are moving fast, however during normal market conditions they provide too many false signals to make them truly effective.
To give you a better idea of how much of an impact these timeframes can have on how we view the market we will be showing a series of charts, all of Bitcoin, in which we will describe what is occurring in each one. First lets look at the shorter term as this is usually where most new traders and investors begin (hint: do the opposite! We always approach the market from the top down, meaning we start from the highest TF and work down to the lowest).
As you can clearly see, this market is heading down. If you were unaware of what security this is referencing or in what temporal context this is, you would definitely say this is a bear market (a bear market is defined as a 20+% move down from the highs). In a vacuum, this security looks like it is most certainly heading lower, however lets back up a step and look at a slightly longer timeframe.
Now it doesn’t look as bad, right?! From this perspective the market appears to be in a bull market, whereas on the 12-hour chart above we were most certainly in a bear market. What a difference an adjustment to timeframe can make! Let's zoom out even more to see what happens when we look at price action in its entirety.
Wait, what the #$*& is going on here?! Well, if we step back to this longer term view we can see that in fact the market was in a trendless consolidation since becoming a liquid asset back in 2013, and it remains so today despite bouts of upside and downside volatility. It’s pretty amazing how simply changing the length of time that we are analyzing can have such a dramatic effect on how we view and potentially trade the market.
5b.) Support, Resistance, & Trend
One of the most basic, but perhaps most important, tools that technicians utilize are lines of support, resistance, and trend. These are important because they give us reference points to key off of as we trek through these frontier markets.
Let’s start by defining terms which are often misused so that we are all starting from the same place. Support levels (lines) are prices at which there should be a floor underneath the market due to buyers clustering around historically significant levels. Resistance refers to price levels at which there should be a ceiling on the market as sellers tend to cluster around historical levels above the current market price. When we refer to trend, we are simply talking the direction in which the market is heading over a specific timeframe (think back to our discussion on Timeframe). The market can either be moving from the lower left to the upper right on the chart (bullish), from the upper left to the lower right (bearish), or within a range between support and resistance levels.
One more thing to discuss is the idea of a breakout or a breakdown, depending on directionality. A breakout typically refers to a situation in which prices move above a well known resistance level thus having the effect of accelerating the move higher. Conversely, a breakdown occurs when a well know support level is breached to the downside, thus having the effect of driving prices even lower at a faster rate.
Now that we have that out of the way, let’s get to some examples so that you can see how useful these tools can be!
You can see the we have identified the $450 level as an area of serious resistance lasting from September of 2014 to late May of this year (2016) which was tagged five times prior to a breakout! This is typical when markets are attempting to move above longer term resistance, just know that the more times a level is touched the more likely it is to be broken.
Also of note is the fact that shortly after the 450 $ level was taken out and the market moved higher, that resistance level then became support on the next substantial selloff (known as a test of support). Since then, $450 has been support going forward and will remain so until it is broken to the downside once again.
Next up we'll take a look at trend...
It is pretty difficult to misinterpret this chart, which is one of the great things about trend analysis: that it is simple and straightforward. You can see that from the September 2015 low to the June 2016 high the market was in a clear and tradeable uptrend, as well as a Wyckoff sell model. Then from June on through today the market has been in a downtrend that looks to be a bullish consolidation pattern. As far as the trend channel goes, the implication is the same whether the trend is up or down. A break above the upper trendline means the market is heading higher, while a break below the lower trendline and down she goes.
In this instance we have yet to break above the current trading channel so there is no reversal signal yet, however it is very close so once that occurs you can bet that buyers will return to the market to drive it higher. Again, these are very informative, yet easy to implement and interpret tools that can provide invaluable insights into how you should be positioned in a given market.
5c.) Momentum & Volume
The final aspects of Bitcoin trading that we want to explore are the ideas of momentum and volume. Tools that allow us to track and analyze price momentum and trading volumes are often referred to as "indicators", and they come in a variety of forms that range from mathematical moving averages to adjusted measurements of buy vs. sell volumes.
Before we delve deeper into this topic we must warn you that there are literally hundreds of different indicators, all of which examine the market in a slightly different way. For our purposes, which indicator is used will be less important than being able to recognize the trend and identify what are know as "divergence" patterns. This is due to the fact that each indicator is calculated differently, but they all tell essentially the same story.
Below we will be showing some examples of what are some of the most popular and applicable indicators for active traders. We will start with the MACD as it is probably the most popular indicator these days. The MACD consists of two lines and a histogram. You can interpret this indicator in a number of ways. First, when the shorter MA line crosses over the longer MA line it means that a reversal could be occurring. Next, a zero-line crossover can be interpreted just like any other crossover in that when zero is crossed coming from the downside to the upside, this is a bullish confirmation (and vise versa).
Additionally, when the MACD is trending with the overall market price then the current trend is being confirmed by MACD. On the other hand, a divergence between market price and the indicator signals that a change in pattern is occurring and a reversal in trend is becoming more likely.
Next we show the Relative Strength Index (RSI) which is interpreted the same way as MACD, except that the RSI adds numerical values to overbought and oversold levels. You can see on the chart below that as the RSI moves closer to oversold territory (20 and below) at least a minor rally ensues, and when the market is approaching overbought (over 80) a pullback materializes.
Lastly are indications of volume, the main one being a simple running total of exchange volumes known as "volume". There are also volume indicators which account proportionally for buying and selling volume, one of the most popular of which is the A/D line (Accumulation/Distribution line). Like momentum, the main thing to keep an eye out for here is divergences from the prevailing price trend as this is a sign that there may be more or less conviction behind a move than it would appear on the surface. We can see an example of this, as well as examples of the A/D line and volume profile, on the chart below.
Notice that volume was confirming the downtrend in late September, but was also progressively divergent hinting at a diminution of buying power up to the point where price reversed on a bullish volume breakout. Additionally, volume has been relatively low during the correction indicating this is an extended bull market consolidation, while the bullish trend on the A/D line recently is confirming the rally. Finally, volume profile looks pretty good however there is a notch around $600 which might need some filling in prior to a resolution higher. Volume is an important confirmation tool for any technical trader so reading the signals on these indicators is a valuable skill for analyzing Bitcoin.
Combining trend analysis, support and resistance levels, momentum and volume indicators, and a knowledge of how to interpret these signals gives us a solid foundation from which to create a profitable trading plan, not just for bitcoin but for any market.