In this chapter, we will have a close look at Technical Analysis (TA). When it comes to trading, TA is the topic that new traders are most likely to be skeptical about. It appears as some crazy science that only some geniuses are able to apply successfully. All you see is some good-looking charts illustrating certain ideas, without any real explanation. I will try to shed some light onto this topic, ushering you into the world of TA. I know that there is a lot of skepticism about TA, but that shouldn’t bother you much. In fact, you should form your own opinion.
Before we get into detail, let me assure you of a few things. Even if you end up totally disliking TA, there is nothing to worry about. There are a lot of great traders out there who use TA and make nice gains. But at the same time, there are a lot of great traders using only some fundamentals or even no TA at all to make nice gains too. For most people, TA and especially day trading may just be too stressful to be applied successfully. The key to successful trading is to find a profitable way that simply suits you best.
There is much more to trading than TA. Fundamental Analysis (FA), which we will focus on later, is just one example. In crypto, you should never put all your eggs in one basket. This is something to always remember. That’s why you should see TA as a possibility to further understand trading and make some gains, not as a necessity. Even the best trader won’t be able to predict everything right. If someone claims so, I would not take any advice from them. Some of the best traders using TA in crypto come from Wall Street. But as you will learn, the 24/7 open markets aren’t the only difference.
The long history of TA explains the availability of various books focusing on this topic. I would particularly recommend Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications by John J. Murphy. It’s the bible of trading. But this book is only one example. If you want to develop extended knowledge about trading and TA, get your hands on more well-known books.
Now let’s look at the philosophy behind TA.
3.1 Why does TA work?
The answer is quite vast and multifaceted. So I will share with you what most traders agree on and what is considered to be the fundamentals.
TA is generally about observing and trying to understand the market and the underlying psychology. Charts alone can’t provide you with any definitive and meaningful answers. So understanding the psychology of investors or traders is crucial, as it helps to recognize their behavioural patterns, which are repetitive by definition.
3.2 Psychology of the market
One really important thing about investing, trading, or picking the right coins is understanding the market. You can’t be stronger than the market. Many people learn this lesson the hard way. Most long-time traders I know are bullish on Bitcoin. All of them know how to read the market sentiment. But you don’t have to be overly bullish on Bitcoin. You can make money in bear markets too.
As the graphs show, Bitcoin makes most of its gains in just a few days over the course of the year. You must know what to do on other days. With Bitcoin bleeding, it can turn the whole market bear. That can sometimes lead to amazing opportunities. You will often hear and read “buy when there is blood on the streets.” If Bitcoin drops sharply, many coins or tokens will lose massively in terms of value. But once again, you need to focus on the Satoshi price and not be distracted by the lost $-value percentage. It is more than logical that they lose on value, as they are dependent on Bitcoin. Trying to buy the bottom before the prices rise again is like trying to catch a knife. Most of the time, it’s very painful or just impossible. But you don’t actually have to. You will learn about minimizing the potential risk in a later chapter. The point to understand here is that it doesn’t make any sense to go all in if the market is likely to go further down.
Overlooking the market and trying to understand the concept of mass and market psychology is helpful. Many older traders use Twitter or large Telegram groups to read the overall setting. The concept of market psychology originated on Wall Street and is quite well approved. Since many traders learned their skills there, they brought the concept to crypto. Many books on this topic are available, and reading them does help improve one’s overall trading success rate. Below, please see a simple visualization of the concept.
We will go through the different stages of the chart in detail, and I will comment on the major points.75-77
1) Optimism: This is the first stage of every investment. You are clearly optimistic about your investment, and you are hoping for some good gains to come.
2) Excitement: As your investment is slowly paying off, you are happy with your entry point and the investment as such.
3) Thrill: With the investment getting more and more successful, you are becoming proud of your entry and how well you did. You start telling people about your smart move and how successful it has been.
4) Euphoria: Your investment is reaching its peak, but you are too blind to see. You feel highly optimistic about getting insanely rich and won’t think about any possible decline. Everyone is now talking about this new and great opportunity and how it will change the world. You will notice some guys posting pictures on social media about getting crypto tattoos, quitting their jobs, and maybe even buying expensive sportscars.
5) Complacency: The price stops moving up, which deeply surprises you. But you are still too confident to think of any actual downtrend. You tell yourself that it’s just a small pause before the next price increase.
6) Anxiety: The market undergoes further correction. You still think it’s a temporary event. But you start to feel a little anxious. There is an increase in talking and the need of reassurance in the community.
7) Denial: You can’t understand that you are actually wrong, because you did so well in the past. You still have faith in your investment and believe that the correction will definitely end soon. You notice many people talking about long-term plans and the negligibility of short-term gains. Some first bearish charts pop up, mostly wrapped as a joke.
8) Fear: The price declines further, and your fear of losing your investment intensifies. You notice other people selling and hear more talk about the burst of the bubble. You start to feel the need to get out of the market.
9) Capitulation: Having lost a huge amount of money since the peak of the investment, you feel the need to protect what is left. You don’t believe that the market will ever come back. Since everyone is selling, you don’t want to be the last one. You lost faith in the market and decide to sell everything you have at this point, no matter how low the price is. You can even see some hate/rage-quit posts in different community channels.
10) Anger: You will be feeling depressed and angry at this point. You will not appreciate any potential profit you’ve actually made and think only about what could have been if you had sold the top. You are searching for someone else to blame, certainly not yourself. You are done with the asset you were so confident and happy with a few months ago. There is mostly silence in every channel, and everyone is moving on.
11) Depression: The wounds of the loss are still deep, and everyone is trying to avoid the subject. People are taking a break or even quitting being involved. You are blaming yourself for being stupid and investing in the first place. Some people who took loans to take part in the game realize their big mistake. All this leads to the existential crisis being shared on social media.
12) Hope: After a critical period of depression, the market is slowly rising again. Deep inside, there is a slight feeling of hope, and some investors start realizing that there is some kind of resemblance to older price actions. You start to notice an increased level of talking and interest again. More and more charts are being posted fitting the idea of a recovering market, but still with a lot of doubt.
13) Relief: The market is still recovering. But hints of new investment opportunities are appearing. The level of positive thinking is rising, and the number of charts representing the sentiment is increasing. More and more people are coming back, slowly opening up again for the possible uptrend. You see the first targets appearing, with the market turning optimistic again.
A: This point represents the worst risk/reward ratio of the whole cycle. The likelihood of a further gain in valuation is low, and the risk of a turn in the market is very likely. Most people joining here are likely to lose a big share of their investment. For anyone who bought in earlier, this would be a good point to exit the market.
B: This is the point of maximum financial opportunity. The market is in a phase of recovery, and it would be the best entry for the next bull run. Entering at this point is definitely challenging and requires a lot of confidence, as no major uptrend is noticeable. The risk/reward ratio is the lowest at this point of the cycle.
Knowing the emotional stages of a market cycle can give you a great advantage in trading various assets, not only cryptocurrencies. It is essential if you focus on day trading and will help you a lot to find the right entry for any given asset. Something you should really try to avoid is trading at the peak points of the emotional cycles. Trading lightheaded at the stage of euphoria is as dangerous as trading angry, because you force yourself to make profit. You will get better with each cycle you go through. Even if it’s hard, try to take it as a lesson, even if you’ve lost money. You can be sure that the next cycle will come.
Now, as you have gained knowledge about reading the market sentiment, there are a few points to add. Trading Bitcoin and cryptocurrency is unlike any other market. Bitcoin may be a complete revolution of the “money” concept, capable of changing the world as much as the Internet did. Consequently, the behaviour of the whole market is most likely to be very different from the regular market cycles. Bitcoin and all the other assets are traded 24 hours a day, 365 days a year. No one can stop that. As a result, it is always good to stay focused on the bigger picture and not to blindly trade the markets. Now, as you’ve gained deeper understanding of the underlying market psychology, we can finally start with the TA basics.
3.3 Candlestick patterns
First of all, the website you will use the most during your journey into the world of TA is TradingView, which can be accessed via the following link: <https://www.tradingview.com>. As an alternative, you could use Coinigy, <https://www.coinigy.com>. It has a lot of supported coins, but as it comes with a monthly fee, I would recommend to start with TradingView.
Let’s begin with a typical chart you will see on TradingView.
The first thing that we will focus on are the red and green bars known as candlesticks, often simply referred to as candles. They are used to indicate the price action during a certain timeframe. For example, see the weekly candles in the chart above. They can give us a lot of important information about the price movement in the given time frame. Generally, you will encounter different types of candles, but they will be telling you basically the same thing. The green (or white/hollow) candles indicate a price movement where the starting price during the time frame is lower than the closing price. Red (or black/filled) ones indicate the opposite. The open and close of a candle’s frame is the so-called body. So-called shadows or sticks on the upper and lower end of the body indicate the high and the low of the certain timeframe.
There are a few other things the candles can tell us. The body, for example, can indicate the selling/buying pressure. If the body is short, there is generally little buying or selling pressure, respectively. The length of the shadow can give you hindsight into the price movements during a certain candle time frame as well. A short upper and lower shadow indicates the price movements near the open and close of the candle, for example. A longer shadow indicates some prices way beyond the open/close of the candle.
But as with nearly everything in life, candles come in all forms and sizes. Look at the ones below.
The Doji is one of the most important and revealing candle in charting. It signals for an equilibrium state between buyers (bulls) and sellers (bears) as a form of indecision. Generally, a Doji has a very short body appearing as a single line. If you spot such a Doji in your chart, you should pay close attention to the candles preceding the Doji. What you see can indicate a trend reversal, especially if preceded by some long-body candles like the ones below.
The candles above are called Marubozu and are characterized by the absence of shadows at the upper or lower end. These also reveal a lot, as they indicate that the bulls or bears were in control over the whole timeframe. Therefore, they are very bearish or bullish, respectively.
Another type of common candles indicating indecision is Spinning Top candles seen below.
Even though the price did not change much, there was a significant inner time frame price action. Spinning tops can indicate a trend reversal too, as there may be no more buying or selling pressure left.
The Hammer (seen above) normally forms during a downtrend, indicating a bullish reversal. The lower shadow is long, and the body is generally short. The colour of the hammer is not important. To notice a confirmation of the reversal, you need to observe the candles following the Hammer. The inverted Hammer also indicates a bullish reversal of a current downtrend. As well as with the previous Hammer candle, the next pattern has to be observed, and the colour is not important. BUT, and this is important, as a Hammer normally appears in a downtrend following some bearish candles, a hammer that appears in an uptrend or preceded by some bullish candles is called Hanged Man. They look the same, but the Hanged Man indicates a bearish reversal often appearing new to a high of an uptrend.
As well as with the Hammer candle, you need to pay attention to the candles following the Hanged Man. The same level of attention must be given to an Inverted Hammer candle appearing in the charts. Although an Inverted Hammer candle is a bullish signal, a so-called Shooting Star candle looks the same but is generally bearish. The only difference is once again the current trend you are in during the appearance of the corresponding candle.
If the Shooting Star candle appears near a high of an uptrend, it further helps to confirm the reversal. As always, focus on the following candles, as the colour of the candle itself is of minor importance.
Up to this point, we’ve learned a lot about single candles and the possible meaning behind their appearance. Now, it is time to have a look at dual of double candle pattern. Grab a cup of coffee or tea and have a look at the first one in the line.
The alignment of two candles above is called the Harami pattern. The single bars above are drawn to indicate the respective trend and to keep the focus on these two important candles making up the pattern. The Harami pattern is usually a sign of a trend reversal. One characteristic is that the body of the second candle can be fully fitted into the body of the preceding first candle, which is bigger. The second candle is often a small bearish/bullish candle or even a Doji. Therefore, the body of the second candle is about half of the first one.
At variance with the Harami pattern is the Engulfing pattern where the second candle is now significantly bigger than the first one. The body of the first one can be totally “engulfed” within the body of the second one. Again, as a sign of current trend reversal, the Engulfing pattern can indicate a strong up or down movement.
One of the last dual candle patterns that we will look at is Tweezer Bottoms and Tops. As the patterns above, they indicate a reversal in the current trend. The two candles should have different colours, and the shadows should be at approximately the same level, indicating the same level of highs (Top) or lows (Bottom) respectively. As long as they feature the same highs and lows, the candles don’t need to look exactly like the ones above. (Body length may differ, for example.). There are some other patterns like the so-called Kicking Candlestick pattern, which can signal a current trend as well. Since this pattern is not very reliable or common, I won’t discuss it further in the context of this book. The following two patterns are more common but harder to spot:
The Dark Cloud Cover pattern should signal for a bearish reversal of the current uptrend. The second candle is therefore a red (bearish) one and has the close below the 50% mark (indicated with an arrow) of the first candle’s body (green). In addition, the opening price of the second candle should be above the high of the first candle. The Piercing Line pattern is the opposite pattern occurring in a current downtrend. The closing of the second (green) candle is therefore above the 50% mark of the first one (red), while the open is below the low of the first candle, respectively. I know that spotting these patterns requires a lot of experience, and it will take some time until you are comfortable using any of them. Even though everything already discussed might seem too overwhelming, you don’t need to spot every pattern or interpret every single candle. Especially, as all those patterns above SHOULD signal for a reversal of change in the current trend. Spotting one of these patterns doesn’t mean that the outcome is going to be what it is supposed to be. You can even find percentages for every pattern that give you an idea how many cases it follows the propagated behaviour in (definitely worth looking into if you’ve now fallen in love with candles). Still, most traders I know focus on the bigger picture of the chart rather than on the candles themselves. But for the sake of making the list complete, I will continue with some candle patterns for now.
We will now be looking into three-candle patterns. Hence, only the important candles are shown, with the smaller bars indicating only the current trend. The Three White (Green) Soldiers pattern is a pretty strong signal that, in most cases, indicates a reversal of the current downtrend or a continuation of the current uptrend. The bodies have approximately the same length with the open of the second and third candles alighted with the close of the previous candle. The highs of these three consecutive candles are creating some higher highs, with each new high of the candle being higher than the one from the preceding candle. The Three Black (Red) Crows should indicate a bullish reversal in the current uptrend or a continuation of the current downtrend. The close of the candles should be below the low of the previous candle, with the lows being generally below the preceding one. Like with the Three White Soldiers pattern, the body of the candles should gradually increase from the first candle to the third. The last candle can even have a very small low or no low at all to further confirm the pattern.
Another strong pattern that can indicate a reversal in the current trend is printed below.
The Morning/Evening Star patterns belong to the group of the generally most reliable patterns out there. The first candle of the pattern follows the current trend and has a long body. The colour of the second candle can be either green or red in both patterns, which isn’t crucial. The body is pretty short; even having a Doji is possible. The third candle is antagonistic to the first one of the pattern, with a long body as well. The close of the third candle is above the 50% mark of the first candle in the Morning Star pattern or below the midpoint in the Evening Star pattern, respectively.
Another reversal pattern with a rather cruel name is the so-called Abandoned Baby pattern.
This pattern consists of three candles, with the first one being similar to the current trend. The second candle is a very small one or a Doji. Note that the second one is not overlapping with either the first or second candle (looks somewhat abandoned), which is contrary to the Morning/Evening Star pattern. The third candle is a long candle antagonistic to the previous trend, indicating a reversal.
Below, please see the last triple candle patterns we will have a look at in detail.
The Three Inside/Outside Up patterns should indicate a reversal at the bottom of a downtrend. They are sometimes referred to as confirmation patterns. The first candle of the triple generally follows the current trend (up or down). The next two candles are antagonistic indicating the reversal. In the Three Inside patterns, the body of the second candle can be fully fitted into the body of the first one. The opposite can be noticed in the Three Outside patterns. The body of the first candle can therefore be fully fitted into the respective second candle. For further confirmation, the close (Three Inside/Outside Up) of the third candle has to be higher than the first candle’s high. The close of the third candle has to be below the first candle’s low in the Three Inside/Outside DOWN pattern, respectively. The patterns are generally considered to be very strong and revealing.
Another triple candle pattern that you could look up because I won’t cover it here is the so-called Three Stars in the South/North pattern.
Up to this point, we’ve already talked a lot about Japanese candles (hence, the names) and various patterns that could indicate a possible trend reversal. Before we close this lesson about candles and move on to some other very important topics, we need to focus on trend reversals very briefly. Although it might seem clear to most readers, a reversal specifies a complete turn in the market. This is especially important to know, as many traders might mix it up with a correction of the market. A correction (sometimes referred to as retracement or pull-back as well) is a move in the market, antagonistic to the current trend, although not changing it. The original trend is still intact in difference to a complete price reversal. The difference is visualized below.
You should clearly see the difference between the market correction (indicated with a frame) and a complete trend reversal in the picture above. Even though the downtrend is a little compressed in the picture above, you can see a clear reversal to an uptrend. It is important to distinguish these two types of market behaviour or price actions as a trader. It’s quite common that traders sell their position way too early upon a correction, even though the current uptrend is still unbroken. There are different factors that help determining the difference between a reversal and a correction, which we will discuss in the course of this chapter. Before we move on to the next lesson, there is one thing I want you to keep you in mind once again. All those candle patterns discussed above SHOULD or CAN indicate a reversal. However, there is never a guarantee.
We will now come to one of the most basic but at the same time most important concepts in trading.
3.4 Support and resistance
Knowing how to identify Support and Resistance is immensely helpful, trading crypto, forex, or any other market. But what is the general idea behind this? Let’s look into the Support at first.
Support and Resistance are generally not set in stone and change over the course of the chart. Those levels should be seen not as some kind of fixed price point but rather as a zone. Support level generally builds up when buyers keep buying at a certain price. There is generally a psychological factor behind it. A set of buyers may see a certain price as being somewhat low and start buying. The increased buying pressure at the spoken level may lead to different things. The potential sellers see the price moving up and will most probably wait to sell at a higher price to increase their gains. Other buyers may notice the buying strength and potential upwards movement and set some buy orders at roughly the same level. Now comes the interesting part. If the price moves further up but later nears the support zone again, the original buyers may start buying again for different reasons. They may have sold on profit during the upward movement and are looking for some good entry again to repeat their successful trade. Others may see a potential loss in value if their entry level is breached. They may start adding to their position to defend their entry price and accumulate more at the level they initially thought was a good buying opportunity. New traders might now want to join as well and notice the price always bouncing back from the certain price zone. Hence, those traders are likely to set their bids near to the support zone as well. A temporary support zone is thus born. Always remember that those drawn support lines or zones should just give you an idea how the market COULD behave nearing the given price level. Traders utilize the market behaviour and price action of the past to try to predict the future as well as possible. Since a support zone is often described or seen as the last point before an uptrend, you will find various different support levels in the charts—especially, since you will have a look at different patterns and time frames when trading. I would generally advice starting with some higher time frames. Intra-day trading is much more complicated and requires having a certain experience, since patterns form and break faster. Since there is a lot of psychology in trading, you will notice that charting some bigger time frame or picture might be more reliable. For example, some very good traders make a living identifying and trading only some major decision points or events.
Now, let’s have a look at the picture from the beginning once again.
Don’t focus on the candles right now and try to identify the major support zone or level of the past months. If you have problems doing so, look at the following picture:
Looking at the line charts instead of the typical candle ones help you in certain ways. Since we are generally looking at some support lines rather than the precise level, line charts may really help you. Some may even use the line charts found on the CoinMarketCap website, <coinmarketcap.com>, for some basic support and resistance analysis, which works pretty well for the overall picture. You may have naturally already done so, but if you want to identify a support level, you need to focus on the point where the price bottoms out or hits the floor a couple of times. Since the pictures above don’t provide you with the ability to navigate, you should have identified a support zone slightly under $6000.
Identifying resistance levels or zones is quite similar to identifying support zones. If we want to identify a resistance zone, we will look at some “ceiling”/“bouncing” point—the highest price reached before the market moves down again. At this point, the sellers overweigh the buyers, preventing a further price increase. Like with support zones, there are many factors contributing to the formation of resistance levels. Some sellers might want to lock in some profit, as they think the certain price is appropriate for the asset. Others might think the price always bounced back in the past and it’s the best opportunity to sell and buy in again at a later stage.
f you want to draw support and resistance zones, there are basically two different ways to do it. Some traders might use the endpoint of the candle bodies, whereas others might take the shadows (sometimes referred to as the “wicks” as well). Since, as I’ve already told you, even some line charts will serve you well trying to identify support and resistance zones, only an approximation might be everything you need if you look at bigger time frames. Now, look at the pictures above once again and try to think about possible resistance zones or levels.
As you see above, line charts can be used fairly easily to draw some basic resistance levels. Note: I did not mark all possible resistance areas. For example, one major resistance zone is the level slightly below $20,000.
As you studied the charts, you may have already noticed that a support zone may become a resistance area if breached. (The same applies to resistance zones becoming new support zones.) This is pretty common, as those levels are important decision points. As a former resistance zone breaches due to a high buying pressure, it will attract new buyers, hoping for some beginning uptrend. But how can you sure that the price broke through the support and resistance zone and that it’s not just a so-called false breakout. False breakouts are generally hard to identify, as you need some confirmation by the price action following the breakthrough event. That’s why, generally, you should wait for some sort of confirmation. You may want to wait until the newly formed support (for example, previous resistance) actually holds as such.
The picture above is an example of a false breakout. The support level is marked in green. You can clearly see the price breaking through this level but soon getting back inside the support zone above the green line. A possible confirmation would have been the price bouncing back at the green line, which was previously the support, before declining further. If you want to trade support and resistance zones, a support level would the point where you open up new long positions/place your buy orders. At the same time, you would close your shorts nearing the support zone. To prevent further harm, your stop loss should be placed below the support zone. The way to trade a resistance zone would be to close your longs/start selling or entering new short positions. Your stops would be set above the resistance zone to minimize possible losses. If you are totally new to trading in general, you may have never heard of short/long positions or the use of a stop loss. I will highlight the basic principles very briefly.
3.5 “Longs” and “shorts”
Long: If you enter the market at a certain price, betting that the price will rise, you enter a long position in the market. You will therefore make profit if the price of the asset you bet on increases.
Short: If you enter the market at a certain price, betting that the price will fall, you enter a short position in the market. You will therefore be in profit if the price of the asset you bet on decreases.
Note: The price increase or decrease of your given asset is always of relative nature. For example, the asset you are willing to long is Bitcoin, which is traded against the U,S, dollar. You now enter a long position at a certain USD value for one Bitcoin, betting that the price for one Bitcoin will rise. At the same time, you are basically short on USD as you bet that the value will decrease relative to Bitcoin. If you enter a short position, it is just the opposite.
Stop-loss: A stop-loss order is basically a sell order, which is executed only if the traded asset reaches a particular price level. They are used to cut losses for a certain entered trade. As no one can predict the market with certainty, a stop loss can be seen as some kind of safety net, preventing high-level losses. For example, you want to trade a support zone as you think the market will not go any lower than the given zone. You would either buy the given asset or enter a long position. Now, you would set a stop-loss order below the given support zone. If the price unexpectedly breaks through the said zone, reaching your previously set price level, a sell order would be placed to limit your losses. Some terms you will often hear about in combination with the ones above are the following:
- Margin trading: Buying on margin refers to the practice of borrowing funds. To be able to borrow funds, you need to deposit a certain amount of money, which is referred to as “margin.” As borrowing funds is never free, you will need to pay a certain fee to your broker/provider.
- Leverage: Margin and leverage are tightly connected, as your margin is basically used to create leverage. Leverage is commonly expressed as a ratio and is basically the possibility to trade with amounts of money larger than what you own. Depending on the required initial margin, you can calculate your maximum leverage possible. Let’s go through one simple example very quickly. As I strongly advise against trading on a very high margin (I personally would advise you to never use a leverage greater than 10–15x), we will use the 10x leverage for our example. We would now be able to trade a position ten times greater than our actual funds ($100,000 with $10,000). The margin needed to borrow the needed funds is often expressed as a percentage of the total amount of the position you want to take. If the margin is 10 percent and you want to control the said $100,000, you would need to set $10,000 as a margin. As you can use the margin to calculate the maximum possible leverage, a margin of only 1 percent would grant you the ability to control the same amount of money ($100,000) with only $1,000 USD as a margin. The resulting leverage would be 100:1. If you still own $1,000 USD, but the margin is set to 2 percent, you will be able to control $50,000 resulting in a leverage of 50:1. You now may ask yourself what the purpose of margin trading is, in general. The answer is quite simple this time: to maximize profits. Once again, a quick example: This time you own $10,000 that you would like to use to short/long Bitcoin. As we though the Bitcoin price would rise, we took a long position. Given the fact that we successfully predicted the market, we made 10 percent gains, resulting in now $11,000 in total. It is interesting to see what our potential gains would have been if we had used our $10,000 as a margin to control $100,000 instead. As we initially set the $10,000 as a margin, and a 10 percent increase on $100,000 is $10,000, we actually would have made a 100 percent gain. Note: this is a basic example for educational purposes, as no fees are included.
This now may all seem very interesting and simple, but I can assure you that people’s losses in margin trading are much higher than their profits. I would not advise trading with leverage as a beginner, because it will only frustrate you. If you love to gamble or just love the additional adrenaline, I would recommend taking a deeper look into all of this once you become more experienced in general trading.
Before we move on with a very important lesson about trendlines, we will have a look at the possible market conditions
3.6 Market conditions
At the beginning of this chapter, I tried to raise awareness about the importance of market cycles and the underlying psychology. Understanding the market sentiment will benefit you in various ways, not limited to trading in general. Let’s look at understanding how different market conditions can influence your trading and how you can identify them.
Basically, there are two different market conditions: Trending & Sideways (often referred to as Ranging as well). If there is no clear trend (up or down) to be identified, with the price moving within a given range, the chart is basically going sideways. You might be able to identify support and resistance as boundaries sometimes, but there is no strict need for it. In opposite to the sideways price movement, there is a trending price action. The price can either move up (Uptrend) or down (Downtrend). Even though you might see some insane price actions in a short timeframe when trading cryptocurrencies, the overall price movement is more than just up and down. Take a look at the diagrams below.
You will basically see the following specifications depending on the market conditions:
– Higher highs (HH)
– Higher lows (HL)
– Lower lows (LL)
– Lower highs (LH)
The chart above demonstrates the way a trending market is made up of various price swings. Even if the whole market is clearly in an uptrend, you can see some sideways price action and even some price drops. Higher highs and Higher lows can therefore help describing these intra-uptrend price actions. It might sometimes be hard to identify them clearly, but they are still helpful to plan your next trading moves. Now, it is time to focus on another very important and helpful tool in trading.
3.7 Trend lines
Drawing trendlines is at the same time one of the most commonly used and most powerful tools when it comes to trading and TA. Utilizing this tool is quite simple, but there are some basic steps to draw trendlines correctly. In general, you need at least two significant highs or lows to draw a trendline. (Although some traders prefer to wait for at least three confirmed contact points for further validity.) Depending on the direction of the current trend, the trendlines are either drawn along the top (above the price) or bottom (below the price).
Fitting the chart correctly is important. Violently trying to make the trendline fit won’t help, as the line will lose validity. To draw trendlines, you can use either the bodies or wicks. As both are acceptable, I would use the one that simply suits best. Note: As always with TA, you won’t be able to draw trendlines that fit just perfectly most of the time. But even if some wicks or bodies slightly break your line, always try to draw them as correctly as possible, because trendlines are very helpful in trading and further increase your chances of predicting the market successfully. Depending on the current trend, the trendline can be seen as either support (downtrend) or resistance (uptrend). A break through the trendline can therefore be a good trading opportunity, as the support or resistance can no longer be considered as valid.
As false breakouts can and do happen, it is generally advisable to wait for further confirmation (in the form of a candlestick definitely closing on the other side of the trendline / retesting the trendline as new resistance or support) before starting to trade the breakout. Now that you are more comfortable with drawing trend lines, we will move on to the next lesson.
3.8 Price channels
Price channels are formed or can be drawn as the price trades between two distinct boundaries for a certain time. The most important part about drawing price channels is making sure that the drawn trend lines making up the channel are strictly parallel. This is very important because, as with the previously discussed trend lines, incorrect drawn price channels will lose their significance.
There are three possible price channels: in an uptrend, a so-called Ascending channel; in a downtrend, a so-called Descending channel; and finally, a so-called Horizontal channel, which can be drawn upon a sideways or ranging price action. To successfully draw a price channel, you will need at least two tops/highs AND two bottoms/lows. When drawing price channels, make sure that most candles are within the drawn boundaries. As always, it is almost impossible to draw a perfectly fitting price channel.
Trading based on price channels is possible in various ways. If we presume that our drawn channel will help us to correctly predict the price movement, we could short as the price is hitting the upper border or long if the price is hitting the lower border. A breakout through the price channel can be a good trading opportunity as well. To have further confirmation of a true breakout and to make sure it’s not just a false one, wait for a candle close outside the boundaries. (A retest of the trendline as new support/resistance is used for further confirmation.) A break of the upper boundary could be a good opportunity for a long position, whereas a break of the lower boundary would imply taking a short position. Price channels can be a very helpful tool for predicting possible further price movements. In the previous lessons, we focused a lot on different lines that will help us on our way to trade successfully. Over the next few pages, we will now focus on the most common chart patterns and formations.
3.9 Chart patterns
If you’ve already followed some charts and especially analyses of them, you will most likely have already seen some of the basic chart patterns we are going to discuss in this lesson. We will start with a very common one:
3.9.1 Double Top and Double Bottom chart pattern
Both being reversal patterns, they indicate a complete change of the current trend. The Double Top pattern is a bearish chart pattern often formed after a significant uptrend. Successfully potting this chart pattern can therefore lead to rewarding trading opportunities. The Double Top pattern forms when the price is rejected at a certain level two times, and then reverses to a so-called neckline.
The Double Top chart pattern is considered valid only when the price truly breaks through the drawn neckline. Once the price breaks through, you can either start selling or short the given asset. As the height of the double top formation (neckline to top) is often approximately the same as the height of the drop upon a break of the neckline, you can estimate possible price targets. Basically, the opposite to the Double Top pattern is the Double Bottom chart pattern, which you can see below.
As you can see above, there are clear similarities between those two patterns. The Double Bottom is a reversal pattern occurring after a significant downtrend. This time, the neckline is marking the top of the formation with two lows below it. As the price breaks the neckline this time, it indicates a trend reversal and as such upwards movement of the price. This can also be a good trading opportunity as you would now enter a long position or set buy orders for the given asset above the neckline. Try to wait for confirmation in the form of a retest of the neckline as new support before being sure it’s a good opportunity. Your stop loss would therefore go below this support line to prevent further losses. As with the Double Top pattern, the height of the formation can give you a good idea of possible price targets to look for.
Another famous trend reversal chart pattern is the following:
3.9.2 Head and Shoulders chart pattern (H&S)
There are two versions of the H&S chart pattern. The antagonistic pattern to the regular H&S pattern is called Inverse H&S. As already mentioned, both are trend reversal patterns and indicate either an upward (inverse H&S) or downward movement (H&S). The H&S pattern is generally made by two shoulders (peaks), one head (highest peak), and once again a neckline as a boundary. The head is always the highest point of the pattern, and the shoulders are on approximately the same height. In addition, there is, generally, no need for the headline to be solely horizontal to be reliable, even though the diagram below may suggest so.
As you can see above, the H&S pattern indicates a possible trend reversal, which results in certain trading opportunities. As always, wait for confirmation of the breakout through the neckline to take position. You can either start shorting or selling upon the neckline breakthrough, with your stop loss placed above the given neckline. To equate possible price targets, you can measure the height between the neckline and the head of the pattern. Basically, the opposite applies to the Inverse H&S chart pattern.
As you can see above, it follows after a downtrend and can possibly imply a trend reversal to the opposite. Hence, you would start buying or taking a long position upon the break of the neckline with the stop loss below. There can be a retest of the neckline as a support like in the diagram above, which you can look for as some further confirmation of the reversal. In the next lesson, we will focus on a different kind of chart pattern:
3.9.3 Triangle chart patterns
There are three different Triangle chart patterns: Symmetrical, Ascending, and Descending. Let’s begin with the first one.
The symmetrical triangle pattern is known to indicate price consolidation. Triangle patterns can be hard to identify, but there are a few points to focus on. As we focus on the symmetrical triangle, we are looking for some lower highs and higher lows in the chart. The consecutive lower highs make up the upper line of the triangle whereas the consecutive higher lows make up the lower line, meeting to form the tip of the pattern.
As the Symmetrical Triangle pattern is mainly found when the price is consolidating, a breakout to both sides is possible. If you want to trade this chart pattern, you would place your entry either below the lower line or above the upper line. Try to wait for a conformation before entering. As the height of the back of the triangle often correlates with the height of the breakout, possible levels to take profit can be identified.
Quite similar to the Symmetrical Triangle is the Ascending Triangle chart pattern except that it’s just the lower line that is sloping.
As you can see above, the upper line is horizontal, which makes up the resistance. The lower line is again characterized by higher lows, resulting in the ascending character. You can see buyers having the upper hand, resulting in a breakout to the upside in most cases. BUT the ascending triangle is far from providing 100 percent certainty. Either way, it may be a good trading opportunity. You could therefore enter after the breakout of the upper resistance with your stop loss beyond it. Possible price targets are identified the same way as in the case of symmetrical triangle discussed above.
The opposite to the Ascending Triangle pattern is the Descending Triangle pattern we are focusing on now.
At variance with the ascending triangle, the first line is now made up of consecutive lower highs, whereas the lower horizontal line is a support level; the bears are in control of the price; and the breakout will happen to the downside in most of the times. Even though it won’t always be reliable, you could aim for an entry upon the break of the support line. The height of the triangle can once again be a good indicator to take some nice profits.
For the next lesson, we will focus on some different chart patterns.
3.9.4 Wedge chart pattern
There are two utilized Wedge chart patterns in trading. Depending on whether the chart patterns appear in the downtrend or uptrend, it will either signal a trend continuation or reversal.
The Rising Wedge pattern
The Rising Wedge pattern is formed when the price is making higher highs and higher lows at the same time. This results in two upwards sloping lines considered as support and resistance. The consecutive higher lows are formed at a higher rate resulting in a steeper second support line.
If the rising wedge occurs in an uptrend, like the one visualized above, it signals a reversal of the current trend. The possible trading opportunities therefore result upon the break through the lower support line.
If the rising wedge occurs in a downward movement, it slows down the current trend for a short moment before the downtrend continues upon the break of the lower line. The Rising Wedge chart pattern appearing in a downtrend is therefore a continuation pattern. As the rising wedge leads to either a new downtrend or a continuation of it, the Rising Wedge pattern is generally considered to be a bearish one. Possible price targets can once again be identified by measuring the height of the back or opening of the wedge.
The Falling Wedge
The opposite to the previously discussed pattern is the Falling Wedge chart pattern. As the Rising Wedge pattern, it can signal for either a continuation or a reversal of the current trend. This time, the price movement is characterized by lower highs and lower lows, resulting in the typical appearance of the pattern.
If the falling wedge occurs in a downtrend, it indicates a trend reversal.
If the falling wedge occurs in an uptrend, it signals a continuation of the upward price movement, after a short-time slowdown. As the falling wedge results in a price movement to the upside, it is generally considered to be a bullish chart pattern. To trade the Falling Wedge chart pattern, you would try to enter upon the break of the upper line, placing your stop loss below.
3.9.5 Bearish and Bullish pennants
Next, we will have a look at another continuation pattern called Pennants. They can be seen as a short slowdown or pause after a significant move of the current trend. As the price often forms some sort of triangle during this short period of consolidation, the resulting structure was name-giving. Let’s start with the first one.
The bearish pennant forms after a sharp and almost immediate drop in price. The small time period of consolidation is then followed by a continued downward price movement.
Pennants usually signal quite strong moves, and this time the height of the previous drop (“pole”) indicates possible level for profit taking. The bearish pennant could provide a good opportunity for a short entry or a sell order upon the breakout. Wait for further confirmation by a candle close outside of the pennant and place your stop loss above the formation.
The opposite to the bearish pennant, but still a continuation pattern, is the bullish pennant chart pattern. The pennant occurs after a sharp upwards price movement, followed by a short period of consolidation before a further increase in price.
The short range of consolidation making up the actual pennant can be quite small in comparison to the pole, which is pictured by the significant price movement prior to that. As the height of breakout correlates with the height of the pole, it is a good way to recognize potential profit areas. The breakout to the upside can be a good opportunity to either take a long position or place buy orders to benefit from further price gains. As always, wait for confirmation and place your stop loss below the pennant to stay safe.
Another continuation pattern and somehow quite similar to pennants are Flag patterns. They are said to be very reliable and therefore helpful, although sometimes hard to spot. As with the previously discussed pennants, flags occur after a strong significant price movement up or down, resulting in the two possible versions of the flag chart pattern.
Bullish Flag pattern
As we are talking about a continuation pattern, the Bullish Flag pattern occurs after a sharp upwards movement. The strong move is followed by a short period of consolidation before the upward movement continues. The price movement during consolidation results in two parallel lines making up a channel, resembling a flag.
As the Bullish Flag pattern represents a good opportunity for a buy-in, you would try to enter upon the break of the upper trendline. Once again, you can use the height of the previous uptrend before the Flag pattern formed, to evaluate potential profit zones.
Bearish Flag pattern
The Bearish Flag pattern is basically exactly the opposite to the Bullish one.
To trade this pattern, you would put your sell or short order below the lower trendline, with your stop loss set at the level of the highest point of the upper trendline. Spotting these patterns can be very lucrative as confirmed Flag patterns lead to major price movements in most of the cases.
Another quite similar continuation pattern is the one below.
3.9.7 Rectangle chart patterns
As with most of the previously discussed patterns, the Rectangular chart pattern comes in two possible versions as well.
The Bearish Rectangle occurs after a major downward price movement, as the price consolidates for a short period of time.
As you can see above, the consolidation period is made up of two parallel lines that represent support and resistance levels. Upon the break through the lower resistance line, the downward price movement continues.
The Bullish Rectangle chart pattern follows after a strong upwards price movement in combination with a period of price consolidation.
Just like with the bearish rectangle, a breakout through the respective line, is followed by a continuation of the current trend. To estimate possible profit areas, we can measure the height of the rectangle, as the price movement is most likely to be at least of the same height. If you want to trade these respective patterns, you would look for an entry upon the break of the respective support or resistance line. A stop loss should be set at the level of the opposing trendline.
So far, we’ve focused quite a lot on candles, patterns, and formations. In the next lessons, we will focus on some other tools and indicators that can help us to predict future prices.
3.10 Moving averages
The idea behind moving averages (MA) is simple. It is an indicator smoothing out the price action by reducing the impact of short-term fluctuations. But before we move on, let’s see what moving averages look like:
The three different coloured lines in the picture above represent the used MAs. As moving averages represent the average price over a certain period of the past few days, the number of days can be chosen freely and is marked in the upper left corner of the chart. The blue line represents the average price over the past ten days and is therefore marked as MA (10). The red line represents the average price over the past fifty days, MA (50), whereas the purple line represents the average price of the past one hundred days, MA (100).
As you most probably have already noticed, the more days are taken into calculation, the worse the line fits the candles. The reason behind it is quite simple, and we will now have a look at how a simple moving average (SMA) is calculated. For this example, we want to look at the SMA of the past ten days. Note: We focus on the daily closing price to calculate the average, which is the most common. We now simply add up the average closing price of the last ten days and divide the sum by the number of days (ten). A fifty-day SMA would therefore be the sum of the closing prices of the past fifty days, divided by 50. This principle can be used to calculate basically any SMA you like. Now it should become clearer why a higher-period SMA can’t depict the price movement as precisely as a lower-period SMA does. But that’s not a bad thing; it is exactly what we want. Notice that the MA takes only the chosen time period into consideration. An SMA (50) therefore uses only the past 50 values for the calculation. As a new one becomes available, the last or better the first value is dropped.
Besides the commonly used SMA, there is another MA that is favored by a broad range of traders. It is called Exponential Moving Average (EMA). The EMA is helpful, as it provides certain advantages over the SMA. The SMA is susceptible to big price swings or spikes in either direction, as it simply takes every point into consideration. In addition, every point is equal in the calculation, which is criticized by a lot of traders, as most recent price data is regarded as more significant. The EMA therefore represents the most recent price action better than the SMA and is therefore preferred by many traders. But the EMA is not generally better than the SMA. Both have their pros and cons, and you should chose the one that fits you best. If you look at a larger timeframe, the SMA is great to get the overall trend, even though you might miss the perfect early entry. The EMA will react to the price more quickly and therefore be the way to go if you look at a shorter time frame or want to catch trends very early. But you are also more susceptible to false breakouts (sometimes referred to as fakeouts as well) using the EMA, as the slower price reaction of the SMA is quite protective. The good thing is that you can simply use both. If you use <tradingview.com> for example, you can easily use more than one indicator to get a better idea of the current market.
Now that we’ve learned a lot about moving averages in general, it’s time to focus on the possible use cases.
Identifying possible trends is one of the key functions of moving averages and therefore the first thing we will focus on. As they are based on past prices, they can’t really predict new trends; rather, they help confirm the current ones. If the moving average is BELOW the price most of the time, it signals for an UPTREND (B). The opposite is true as well: if the MA is ABOVE the price most of the time, it signals for a DOWNTREND (A).
But this is not the only way to determine a possible trend (up or down). As it is very helpful and often recommended to use more than one indicator, you can do so to better identify the current trends more easily. In an uptrend, the shorter-time period MA should be above the lower-time period MA (e.g., MA (10) being above MA (20)). In a downtrend, it’s exactly the opposite, with the longer-time period MA being above the shorter-time period MA.
Another very common use case for moving averages is to determine possible support and resistance levels. These levels are often considered to be dynamic, as they clearly change over time. We are therefore not looking at traditional lines that we used to do in the lessons before. In general, support and resistance levels in form of moving averages are quite easy to spot. As with the already previously discussed support and resistance levels or zones, it is very common that a support can turn into resistance and vice versa. How moving averages can be used to spot possible trading opportunities is what we are going to focus on next.
If you’ve already played around with multiple moving averages in the chart, you will most likely have noticed a crossover. These crossovers are exactly what we are looking for now. As a short-term MA above the long-term MA signals for an uptrend, a crossover of the respective moving averages could be a good opportunity to either buy or long the given asset. A crossover of the long-term MA over the short-term MA could therefore lead to a significant shorting or selling opportunity (e.g., a special type of crossover—the so-called Death cross). As the name implies, it is a rather bearish signal, which occurs when the MA (50) crosses below the long-term MA (200). The opposite, the MA (50) crossing above the MA (200) is a bullish signal—the so-called Golden cross.
3.11 Moving Average Convergence Divergence
The moving average convergence divergence, or simply MACD, was first invented by Gerald Appel in the 1970s (233). Since then, it has become one of the most common indicators used in TA. It is used to confirm a momentum or to identify a new trend. The MACD indicator is shown in the chart below and provides various types of information.
Just to remind you, the button used for adding different indicators is marked with a blue frame in the diagram above. You can easily search through a broad range of different indicators. It is important to note, that two lines above are not just two mobbing averages of the price, but the difference between them. If you use standard setting, you will most probably see the following numbers: 12, 26, 9 (marked with a red frame in the diagram above). Those numbers are derived from the past days of trading and represent the typically used setup.
The MACD line is therefore calculated by subtracting the longer-term moving average (EMA (26)) from the shorter-term exponential moving average (EMA (12)). The third number (9 in the typically used setup) represents the number used to calculate the difference between the two MAs (basically, a nine-day EMA of the previous calculated MACD line). If the short-term EMA moves away from the long-term EMA, the process is called divergence. The opposite is defined as convergence. The bars in the background (histogram) simply visualize the difference between the two MAs. If you look at the right side of the MACD indicator area shown below the chart, you will see positive and negative values. A MACD valuation of 0 corresponds to the equation EMA (12) – EMA (26) = 0. If MACD > 0, it corresponds to the short-term average located above the long-term average. If the MACD has a negative value, it’s exactly the opposite. This information can help us to get an idea about the current momentum, as a negative value signals for a downward movement.
But the thing most traders look for is, once again, crossovers. As we look at moving averages of different time periods, the EMA (12) reacts faster to any price movements, leading to some possible crossovers upon a change in the trend. Note: As the histogram visualizes the difference between the two MAs, it vanishes during a crossover. A bullish crossover occurs if the MACD (blue line) crosses over the signal line (red line). A bearish crossover therefore occurs when the MACD crosses below the signal line.
But the crossing lines are not the only crossovers to focus on. If the MACD line crosses the midline (where the MACD is 0) and turns positive, it is considered to be a quite strong bullish signal. The opposite is true if the MACD crosses the line to turn negative. The histogram can also tell us something about the strength of the trend. As the histogram gets bigger, which equals an increasing divergence, it indicates a stronger trend. As you can see, the MACD is really helpful in various ways to further understand the market. Always remember that the MACD is based on past prices, which is why it tends to lag behind.
3.12 Bollinger Bands®
The Bollinger Bands (BB) indicator was invented by John Bollinger and is used to measure price/market volatility. If you take a look at the chart, you will see three lines. The one in the middle is simply a 20-day moving average like we already discussed before (SMA (20)). The upper and lower band are drawn by the help of a formula, which takes standard deviation into calculation. If you use default settings, two standard deviations are commonly used. This means that 95 percent of the price action happening is based within the upper and lower bands. Depending on your needs, the default settings can be adjusted easily. For example, Bollinger suggests using a standard deviation of 2.1 if you are focusing on a SMA (50) or 1.9 for a SMA (10) (234). The default settings are marked in red in the diagram below.
So how can we make use of the Bollinger Bands in trading? There are two primary use cases.
As already mentioned, it can measure price volatility. If you take a look at the diagram above, you will see that the space between the two outer lines is dynamic. A high distance between these two indicate a high price volatility. Narrow bands indicate the opposite. Narrow bands can indicate a good trading opportunity, as a breakout in either direction begins to seem likely. As the upper line can be seen as dynamic resistance and the lower line as dynamic support, a breakthrough of the respective line is usually followed by a strong upward/downward movement.
The second primary use case focuses on the said lines to determine so-called overbought and oversold price levels. If the price touches the upper band, the asset is said to be overbought, and you would sell or short the given asset. If the price touches the lower band, you would be looking to buy or long the given asset, as the price tends to bounce back and move to the middle line. This technique works pretty well if the market is in a sideways movement (ranging).
Examples of the price touching the upper or lower band are marked black in the picture above. Note: Even if using the upper and lower band as a trading signal can work out most of the time, the price touching one of the outer bands shouldn’t be seen as a definite signal. The price only TENDS to move back to the middle line. Either way, using the Bollinger Bands in combination with other indicators or patterns can definitely help further predict possible price actions.
3.13 Stochastic Oscillator
The stochastic oscillator was invented by George Lane and represents a momentum indicator that can help us to determine a possible trend reversal. As the momentum changes before the price, the use of the stochastic oscillator can help identify promising trading opportunities. As in the case of the MACD indicator, you will see two coloured lines (stochastic lines) that we will be focusing on. In addition, you will see three distinct zones within which these lines move. The central zone can be highlighted with a different colour, like in the following example below.
By default, the stochastic oscillator is defined for the 0–100 range, resulting in the following definition of the three displayed zones: The middle zone between the values of 20 and 80 is considered to be neutral, with 20 and 80, therefore, being considered thresholds to either overbought (>80) or oversold (<20). For example, if the Stochastic lines are in the oversold zone, the price nears its low for the shown time span, which could signal for a coming upwards movement. The stochastic lines, therefore, fit the candle chart pretty well. Note: As you can see in the picture above, a high USD value movement in the candle chart does not directly correlate with the movement of the stochastic lines into the respective overbought or oversold zone. As the primary purpose of the stochastic oscillator is to determine the momentum and therefore indicate where the market condition imply that the given asset could be overbought or sold, we can use it to spot possible trading opportunities. If the stochastic lines indicate that the market is overbought for a certain time period, it might be a good entry to short or sell the given asset. The opposite applies if the market is oversold. The stochastic oscillator can therefore be a valuable addition to your trading setup.
3.14 Relative Strength Index (RSI)
Quite similar to the previously discussed stochastic oscillator is the relative strength index (RSI), which was invented by J. Welles Wilder. The RSI is used by a very broad range of traders and definitely belongs to the most famous indicators. As the stochastic oscillator, it is a momentum indicator that scales from 0 to 100. You will again notice three distinct zones, with a slightly different division. The mid-zone ranges from 30 to 70, shifting the oversold threshold to 30 and the overbought threshold to 70. As such, the RSI moving above 70 indicates overbought market conditions and might suggest a possible trend reversal to the downside. If the RSI moves beyond 30, it can indicate a possible trend change to the upside as the market condition gets oversold.
As you can see in the picture above, the RSI resembles the price movements. Besides its primary use case of determining oversold or overbought market conditions, the RSI can be helpful to determine possible trends. If the chart indicates a possible reversal or the formation of a new trend, you should have a look at the midpoint of the RSI scalation (50). A value above 50 can signal a possible uptrend as more traders are buying the assets rather than selling them. A value below 50 indicates having more sellers than buyers, and signals for a possible downtrend. Note: Even though it is possible to change the standard settings of the RSI, I would not advise to do so, as they generally provide the best results in most of cases. The RSI is generally a great addition to your trading setup and works even better in combination with other indicators like the one we are going to discuss now.
3.15 Ichimoku Kinko Hyo
As the name implies, the origin of this indicator lies in Japan. The indicator is often referred to as Ichimoku Cloud in daily usage, and you’ll know why in a minute. A journalist named Goichi Hosoda developed the Ichimoku Kinko Hyo (IKH) Indicator, which may be loosely translated as “one look at a chart in equilibrium.” The Ichimoku cloud can provide you with a whole bunch of information and therefore looks really complex.
As the IKH is used to identify support and resistance, trend directions, and momentum, it becomes clear why there are more than one simple line. The first thing you will probably notice is the red and green areas. This range bordered by two lines, and this zone, are referred to as Ichimoku cloud. Another important thing you may have noticed is that this area precedes the actual candle chart. This is one of the cool things about using this indicator. The cloud is basically shifted 26 days forward (if you use default settings) and can be used to get an idea of future support and resistance areas.
Before we get to the other very helpful advantages of the indicator, we have to take a closer look at the distinct lines. Let’s start with the cloud once again. The lines limiting the cloud area are called “Senkou Span A and B” and are calculated as follows:
Senkou Span A (green) = (Tenkan-sen + Kijun-sen)/2 plotted 26 time periods in the future.
Senkou Span B (red) = (highest high + lowest low)/2 of the last 52 time periods, again plotted 26 time periods in the future.
The black line in the picture above is referred to as the lagging line and is called Chikou Span. This line helps to determine possible trading signals.
Chikou Span (black) = Most recent closing price plotted 26 time periods in the past.
The Kijun Sen is often referred to as the base line and is highlighted with purple in the picture above. It can help us to get an idea about possible future price actions.
Kijun Sen (purple) = (highest high + lowest low)/2 plotted 26 time periods in the past.
The last line is called “Tenkan Sen” and is often referred to as turning or conversion line. The line is highlighted w blue and can indicate the current trend.
Tenkan Sen (blue) = (highest high + lowest low)/2 for the past 9 time periods.
Note: Even though you will never have to use any of the calculations above, it sometimes helps to know the underlying details. But I can assure you that after using the cloud for some time, the process gets as intuitive as with any other indicator out there. The IKH is a very powerful indicator, and you shouldn’t be scared off by the complex-looking appearance.
As it comes to trading, we will start once again with the cloud. If the price is above the cloud, the trend is said to be bullish. The trend gets strengthened when the Senkou Span A is rising above the Senkou Span B. This gets visualized as colour of the cloud area becomes green. If the price is below the cloud, the trend is bearish. As the Senkou Span B is rising above the Senkou Span A, the cloud space turns red, indicating a stronger downtrend. Besides that, the cloud serves as possible support and resistance levels. If the price is above the cloud, the cloud serves as support level. The opposite is true when the price is below the cloud. The cloud, therefore, acts as resistance.
As already mentioned before, the base line (Kijun Sen) can help us to predict future price actions, as we take a look at the current momentum. If the price is above the base line, it tends to continue the upward movement. If the price is below the base line, the price is more likely to keep declining. The conversion line (Tenkan Sen) can indicate the current market trend. As the conversion line moves up or down, it indicates that the market is trending in the respective direction. Sideways price action and market condition would be shown as a more horizontal line. More importantly, the conversion line together with the base line can indicate significant buy or sell signals. If the conversion line moves ABOVE the base line, it’s a buy signal. If the conversion line moves BELOW the base line, it represents a sell signal. Further confirmation of the signal is provided if the crossing occurs above (buy signal) or below (sell signal) the cloud.
The Chikou Span can indicate possible sell or buy signals as well as give an idea of the overall strength of the current trend. If the Chikou Span crosses the price from above, it indicates a sell signal. The opposite is true as well as the cross-over from below the price indicates stronger buyers and, therefore, a buy signal. As you can see, the Ichimoku Kinko Hyo can provide a very broad range of information, which can help us to predict the market even better.
To further advance our trading skills, we will now be focusing on probably the most known number sequence.
We will start with some mathematical background, but let me assure you that you won’t need to grab your calculator at any point. The Fibonacci sequence has been known as a steady companion of humankind for centuries. The sequence bears the name of the Italian mathematician Leonardo Fibonacci (c. 1175–1250) who was first to introduce and describe the following ratio:
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 …..
In modern descriptions, you will find a 0 at the very beginning of the sequence. Either way, every subsequent third number is the sum of the previous two numbers.
1+1=2, 1+2 =3, 2+3=5, …… 55+89 =144 ,…..
Now, if you divide one of the numbers by the previous one in the sequence, the result always approximates 1.618.
144/89 = 1.6179, 89/55 = 1.6181
The result of the inverse calculation, a number divided by the next in line, approximates 0.6180.
89/144 = 0.6180, 55/89 = 0.6179
If you divide a number not by the next one, but by the one second in line, the result will approximate 0.382. The inverse division would therefore result in 1.382. A number divided by the one three places higher would give you approximately 0.236.
These ratios are the key levels we are looking at in trading and TA. The ratios 1.618 as well as the inverse 0.618 are often referred to as the Golden Ratio. The Golden Ratio and hence the Fibonacci numbers can be found throughout architecture, art, and literature. You will even find some examples in nature, although this statement is debatable.
When it comes to trading, there are various use cases for the Fibonacci sequence and resulting ratios (Fibonacci arcs, fans, time zones, channels). We will be focusing on Fibonacci extension and retracement levels on the following pages. The Fibonacci retracement levels that you will see using the respective tool with default settings are the ones below:
0.764, 0.618, 0.500, 0.382, 0.236, 0
The basic requirement to use the Fibonacci retracement tool effectively is to locate the high and low of the price movement we are interested in. As you set the beginning and the end point of that move, the tool will automatically measure the distance between those points and calculate the respective Fibonacci levels. If you intensely studied the retracements levels above, you may have asked yourself why the 0.500 is included, as it does not directly follow the Fibonacci sequence and ratios. The 0.500 or 50% retracement level indeed does not originate from the Fibonacci sequence directly; rather, it originates from the fact that the price or averages often retrace to half the level of the prior movement. For example, using the Fibonacci retracement tool and therefore knowing the respective levels can provide you with very valuable information about some possible support and resistance areas. But as already mentioned above, the first and most important step is to identify the right points to use the tool correctly. As with trading in general and most other indicators as well, you will need some time and experience to be able to use the Fibonacci retracement tool with confidence.
Using the tool for either an upward or a downward movement, you will always follow the price direction. Hence, the starting point is always to the left of the end point, following the direction of the underlying move. Remembering these simple rules can help a lot in the beginning. For an uptrend, you would set your starting point at the bottom of the movement and the end point at the most recent top. The inverse is true for a downtrend. You would set your starting point at the top of the price movement and the end point on the most recent bottom/low.
Now, take a look at the diagram below.
This is basically what you are going to see if you use the Fibonacci retracement tool for the first time on <tradingview.com>. As you can see above, the starting point is set at the top and the end point at the most recent low. The tool automatically measures the distance and calculates the respective retracement levels. You can easily adjust the standard settings by using the red-marked box in the picture above. Just try it out and use the settings that suit you best. If you use the tool for the first time, you will notice that the tool is not drawing only the respective retracement levels. Above the 1 percent or 100 percent level, you will see some additional marked zones and levels. These are called Fibonacci extension levels and could help you to determine possible profit-taking areas, as they may represent future support or resistance levels. Depending on your settings, you are most likely to see the 161.8 percent extension level as the first one. If you take a closer look at the diagram above, you will most likely notice that the retracement levels drawn are far off from being correct every time. But as you’ve already made it this far, this shouldn’t surprise you at all.
The Fibonacci tool is once again a prime example of the important role that psychology in TA and trading play. The reason why those retracement and extension levels can provide working support or resistance areas is simple. As many different traders use the same tool and most likely same starting and entry points, we will focus on the same levels. The more traders actively focus on the same thing, the more it somehow tends to become some kind of self-fulfilling prophecy. But this explains the weakness of the points as well. Not every trader will use the exact same points in every single case. The Fibonacci levels will therefore be shifted and may not seem to work. But on some key areas or major turning points, Fibonacci tool can be very reliable.
However, it is important to notice that the reliability of the individual retracement level tends to vary. Most of the time, the 0.236 or 23.6 percent retracement level does not turn out to be a major support or bounce area. The levels that seem to be the most reliable are the 38.2 percent, 50.0 percent, and the golden 61.8 percent. The area between the 38.2 percent and the 61.8 percent may seem quite large, but you should consider it as some kind of key or alert zone to focus on.
You will increase your odds for a successful trade immensely by using the Fibonacci retracement tool with all the other skills, patterns, and indicators you have learned so far. As the Fibonacci retracement tool will help you to determine possible support and resistance areas, you can trade them quite similarly. When you spot the price testing a Fibonacci level as a support a couple of times, you could set a buy order near the respective level. Don’t forget to set your stop loss, which would be placed below the retracement level. Depending on your trading style, you could either set it quite near the retracement level holding support or even beyond the next following retracement level. The opposite applies if you recognize a certain Fibonacci level as resistance. As already mentioned, the Fibonacci extension levels beyond 100 percent can serve you well as possible profit-taking areas. It can give you an idea about possible future resistance levels and therefore might be worth watching. With some experience, you will realize that the Fibonacci tool can be combined with trendlines, candle patterns and formations—like flags, for example—to get a better idea about possible price movements. Always keep in mind that the less people watch the same levels the less likely they are going to work out as planned. Using the Fibonacci tool can be quite subjective, but with a certain amount of experience, you will definitely learn to shift the odds in your favour.
3.17 Summary and final notes
In this chapter, we’ve talked a lot about the core principles behind trading and technical analysis. I’ve tried to provide you with as much information as possible about the underlying market psychology, famous indicators and patterns, as well as the most commonly used tools. Although all of this may seem overwhelming, there are a lot other useful indicators and more advanced patterns out there. But even with the best books, videos, or teachers, there are still some points you will need to learn on your own. Trial and error is something crucial when it comes to trading, as you will need to gain your own experience.
That’s why, I would advice you to start keeping a trading journal. This doesn’t need to be very complex, and some programs like Excel or OpenOffice Calc, for example, will work just perfectly. There are some extra programs and templates on the market, but I would still advice you to create one on your own. Keeping a trading journal has many different advantages. It will help you to cut down on your emotions and basically force you to focus on nothing but the actual fundamentals the market provides. You should note down as much information as possible about every trade you enter and exit. Sounds like a lot of work? Yes, but the results are worth the effort. Here are some points that you should definitely record in your trading journal:
- Date and trade size
- Entry and Exit level
- Stop loss
- Market sentiment
- The reason why you entered the trade (e.g., resistance break)
- Recapitulation of the trade
Following the list above will result in a detailed trading journal you can use to further advance your trading skills. It is important to analyze why your trade was successful and more importantly why it wasn’t. This is very important, as such analysis helps you to improve. Maybe your support didn’t hold because of some bad press, or your pattern resolved in a manner completely different from what you had anticipated. You need to write down everything and try to find the reason behind your loss.
Since especially your early days will most likely turn out to be quite depressing, it is wise to start with some paper trades or demo accounts. Basically, you write down everything as if it were a real trade, but you do it without using real money. As the next step, you could start with some small amounts of money to get used to the actual betting process, which is much harder than it seems. You can perform outstandingly on paper, but it still requires mental strength to bet your own money. It will be a lot more stressful and tempting to change your trading behaviour. This is why keeping a trading journal is crucial, as you can analyze every trade you make. It will help you to stick to your targets, and you will be more than happy about beginning to track your trades in detail.
If you plan to start day trading or want to trade more frequently, I would generally advice you to dive deeper into the world of TA. There are some books, blogs, and videos focusing on trading Bitcoin and crypto specifically, but that doesn’t render all other sources useless. TA has a long tradition in the financial markets. That’s why you will find some absolutely great books out there. They may be old, but that doesn’t make them less valuable. Here is a list of books that I consulted while writing this chapter and that I would recommend to you:
- Technical Analysis of the Financial Markets by John J. Murphy
- Trading for a Living: Psychology, Trading Tactics, Money Management by Dr. Alexander Elder
- Mastering Elliott Wave by Glenn Neely and Eric Hall
- Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude by Mark Douglas
- Japanese Candlestick Charting Techniques by Steve Nison
Note, the list above is far from being exhaustive. There are many other great trading books, but the ones listed above are good to start with. Besides books, there are other very helpful sources—for example, online:
These websites are great if you want to quickly revisit a special topic or simply have the ability to view the chart examples at a greater scale than books can provide.
I hope that this chapter has somehow helped to demystify the topic of technical analysis. There is absolutely no doubt that you will need to make a lot of trades to gain enough experience to beat the market at a decent rate. You should never forget that the market is man-made and there are a lot of other traders seeking profits. You will almost certainly develop your very own way of trading and staying in the game.
I would advice you to reduce the number of trades to a very basic level. This will serve you well, especially in the beginning, and will prevent overtrading. Day trading can be profitable, but most traders still lose money. Try to analyze the market and the fundamentals of the asset you are going to trade. Does the overall market sentiment support your trading idea? Is the long-term trend bullish or bearish? Are the fundamentals solid? Although the crypto market can be highly irrational, it is always good to check at least the basics when it comes to fundamentals. This can give you an idea whether there is still ongoing development, active community, and especially demand to justify possible pumps in the future. Is there an accumulation happening? How big are the available supply and the current inflation? And, of course, do the technicals support your idea? Focusing on those questions will naturally cut down the number of trades you make and at the same time increase the chances of profit. But even if you don’t want to trade at all, be assured that there are various other ways in crypto to make some decent profits.