This article, the third in our investing and trading series, focuses on short-term crypto investing using basic technical analysis. We’ll cover simple strategies that involve identifying price trends and resistance levels. Keep in mind that while technical analysis can seem clear after the fact, it often gives false signals. To improve accuracy, confirm each signal with multiple indicators and other types of analysis.
1. Key concepts
Price Trends: A price trend is the general direction in which the price of an asset is moving over a certain period. Trends can be upward (bullish), downward (bearish), or sideways (neutral). Identifying trends helps traders make decisions about buying or selling.
- Uptrend: Prices are generally increasing, with higher highs and higher lows.
- Downtrend: Prices are generally decreasing, signaled by lower highs and lower lows.
- Sideways Trend: Prices move within a limited range, showing little upward or downward momentum.
Resistance Level: A resistance level is a price point where an asset struggles to break through, causing the price to stall or reverse downward. Traders often use resistance levels to identify potential selling points or to set stop-loss orders.
2. Momentum trading tactic/trend-following tactics
Momentum trading is a simple tactic based on the following cryptocurrency price trend. You buy at the beginning of an upward trend, then sell at the end.
Risk: the trend could change at any time, so it’s important to monitor price momentum and trade volume and adjust as needed.
Recommendation: You should establish clear entry and exit points, don’t be greedy or knee-jerk reaction. As you can see in the example below, the trend persisted even after significant dips. Monitor metrics such as trade volume, liquidity before and during the trade to confirm the trend.
3. Pulling back tactic/ Counter-trend tactic
Even during an uptrend, pullbacks occur frequently. As a counter-trend trader, you want to buy at the pullback and profit when the price continues its upward trajectory.
Risk: there’s always a possibility that what seemed to be a pullback could be a momentum reversal. It’s crucial to maintain discipline and prepare an exit strategy.
Recommendation: This is a highly risky tactic. You should establish clear entry and exit points and practice risk management carefully.
4. Range trading tactic
During a trend, the price line sometimes consolidates along a narrow channel, between a resistant line and a supportive line. You can exploit this by buying when it hits the supportive line and selling when it hits the resistant line.
Risk: the price could break out unpredictably from the channel, leading to you exiting the upward trend, or entering at a premium.
Recommendation: After a breakout, don’t react emotionally. Remember that if you sell before a rally, you still making money. If you buy at the top, monitor the trend carefully before you realize the loss.
5. Breakout trading tactic
After the pricing has fluctuated along the supportive and resistant lines, a breakout can lead to a significant movement in the direction of the breakout. You can enter right after the breakout for a quick gain.
Risk: weak breakouts may not rise as high as your target, even falling back into the range.
Recommendation: This is a highly risky tactic. It requires quick reactions, and you often don’t act with the full picture. You must manage the risks carefully.
6. Double tops and double bottoms pattern
Double tops and double bottoms are well-known patterns that predict potential trend reversal. You can look to sell after double tops or buy after double bottoms. Even though they are simple patterns, or perhaps because of it, Double tops and double bottoms are hard to use because they can be confused with many other patterns and easily missed.
Risk: Double tops and double bottoms pattern are not 100% accurate.
Recommendation: They should be used in conjunction with other tactics.
7. Head and shoulders pattern
Similar to Double tops and bottoms, the Head and shoulders pattern is widely known as a reversal predictor when the price line breaks out of the neckline. The head and shoulders pattern consists of three consecutive peaks, with the middle peak being the highest, forming a head. The two lows in between the peaks create the neckline. Head and shoulders pattern is more reliable than Double tops and Double bottoms, but also harder to find.
Risk: Head and shoulders pattern is not 100% accurate.
Recommendation: It should be used in conjunction with other tactics.
8. Fibonacci retracement patterns
This pattern, named after the Fibonacci sequence, is a popular technical analysis tool among traders.
Traders take the lowest and the highest price points of a time frame, then draw horizontal lines at the 23.6%, 38.2%, 50%, 61.8%, and 78,6% mark between the points. These lines serve as support and resistance lines to monitor for potential price reversals, as shown in the image above.
Risk: The Fibonacci retracement is not 100% accurate.
Recommendation: It should be used in conjunction with other tactics.
9. Elliott wave theory
Elliott wave is a trend following price movements, consisting of 2 phases: impulse phase (consisting of 5 sub-waves) and correction phase(consisting of 3 sub-waves). Elliot waves are fractals meaning that each full Elliot wave can also be a subwave of a larger wave.
Characteristic of Elliott wave:
- Wave 2 can’t retrace more than the beginning of Wave 1
- Wave 3 can not be the shortest wave of the three impulse waves, 1, 3, and 5
- Wave 4 does not overlap with the price territory of Wave 1
- Wave 5 needs to end with momentum divergence
Elliot waves are useful for anticipating price trends and reversals. However, the Elliott wave is not easily recognized and can be subjective. What can look like wave 3, could be wave 1 of another Elliot wave. You need to update their wave counts as new prices fluctuate.