In the previous lesson, I discussed how to use fundamental analysis to understand specific cryptocurrencies you’re interested in, develop a directional bias (“bullish” or “bearish”), and then determine if any look like potential trade ideas (go “long” or “short”).
Once you’ve got your directional bias based on fundamental analysis, it’s now time to determine potential entry prices (“entries”) for your trade, as well as exit prices (“exits”) to take a profit or cut your loss.
For a discretionary trader, this is typically done using technical analysis (TA) and price action (PA).
In this lesson, you’re going to learn how to use technical analysis and price action to identify entry and exit points when trading crypto.
What is the market price?
But before jumping into what TA and PA are, we need to have a quick discussion on what the market price is and why it’s constantly changing in the financial markets.
Price is essentially the value at which a buyer and seller agree to make a trade.
For example, pretend we’re at a farmers’ market, and let’s say a farmer is selling a bag of apples for $1.00. If you or someone else agrees that’s a fair price and gives $1.00 for a bag of apples, then the market price is $1.00.
Now, if no customers buy a bag of apples for $1.00 that day, then the farmer may lower the price to $0.95 (or lower) until customers start buying.And vice versa…. if buyers buy out all of the apples at $1.00 and are asking for more, the farmer will likely raise their price for a bag of apples to $1.10 (or higher) until the demand for apples slows or stops.
It’s the same with financial assets, but on a much, much larger scale. In the financial markets, there could be thousands upon thousands of buyers and sellers for a single asset, all with different ideas of how much they’re willing to buy/sell and at what price.
And these transactions happen at a much faster pace, many in as little as fractions of a second, depending on the asset being traded.
With so many market participants and transactions happening every second, the market price will move constantly, depending on the balance between buyers and sellers. Or in other words, the balance between the asset’s supply and demand.
It’s impossible to know exactly what each market player is up to and their reasons for buying or selling at specific prices.A spectrum of players from small retail “fish” to large institutional “whales” could be trading based on a narrative based on fundamentals, pure speculation on price action, or something as obscure as the migration patterns of African elephants.
It’s basically impossible to know what every trader is thinking so the best we can say about any market environment is that the price reflects all known public information about the asset and what the collective feeling is on that asset’s outlook (i.e., market sentiment).
That brings us back to price action and technical analysis.
What is price action? What is technical analysis?
Price action and technical analysis is the practice of understanding the market sentiment of an asset through a visual or mathematical framework around price history.
Through this lens, a trader can understand when market sentiment was bullish, bearish, or neutral, and be able to find potential points of inflection or sentiment change.
To illustrate this concept, let’s do a quick analysis using price action and technical analysis on bitcoin against the U.S. dollar (BTC/USD) to see what traders are feeling:
In the chart above, we have BTC/USD price action on the four-hour timeframe, and in terms of price action, we can see that in the month of November, traders were bearish as they took the market from near $70,000 to as low as $54,000 before the month end.
We can also see that $58,000 and $60,000 were strong areas of interest, first acting as a support area in October, then breaking in November and turning into an area of resistance, telling us that could be an area that draws in sell orders if bearish sentiment persists.
Or it could be an area that draws in buy orders if the price breaks above in the near term.I also have a technical indicator in the chart at the bottom, the MACD indicator. This indicator is used by many traders to show them when price momentum may be peaking.
And in this scenario, the MACD’s move higher may be signaling that the short-term pop higher in BTC/USD price from $54,000 to $58,000 may be overdone, adding a TA argument that traders may resume the selling pressure.
So if your fundamental analysis is telling you that BTC/USD could potentially see more selling ahead, then this chart analysis supports a similar point, strengthening the bear case.
Did that make sense?
If that all seemed alien to you, don’t worry! You can learn more about MACD and other technical indicators by reading our technical analysis lessons for beginners in our School of Pipsology!
But before checking it out, here are some tips to keep in mind before you start off on that journey.
Tips on Using Technical Analysis and Price Action
There IS such a thing as “doing too much” when it comes to technical analysis and price action.
Throwing up too many indicators tends to lead to a phenomenon called “analysis paralysis.” This is where indicators start conflicting with each other as some tools flash “buy” signals against others saying it’s time to “sell.”
Study the different TA and PA tools and find no more than 2 or 3 that make the most sense to start your journey with and practice religiously.
Multicollinearity is a statistical term referring to the use of the same type of information more than once. Successful use of technical analysis requires avoiding multicollinearity when using multiple technical indicators. You want to avoid using technical indicators that are “collinear” in that they are based on very similar or related input resulting in redundant information.
Don’t use technical analysis or price action alone as a trade idea generation tool.
In most cases, you should not use TA or PA by themselves as a trade idea generation tool, especially for crypto assets.
Technical analysis and price action are always backward-looking, so they will NOT tell you when potentially major catalysts lie ahead or give you the knowledge as to why market sentiment is leaning one way or the other.
By using technical analysis and/or price action as your only analysis tool, you increase the odds of being blindsided by a surprise event.
For beginners, that’s why I recommend using fundamental analysis to generate trade ideas, and then using technical analysis and price action to find trade entries and exits.