In the previous article Introduction to Technical Analysis: Decoding the Language of the Markets, we saw how cryptocurrency traders use technical analysis to make informed decisions. In this article we will delve deeper into the study of technical analysis, examining in more detail the tool that underlies technical analysis: the price chart.
The Price Chart
As we will see later, the price chart offers a clear visual representation of price movements over time. By simply analyzing the fundamental elements of a chart, you can gain valuable insights from the data and make informed tradingTrading Trading is a speculative activity of buying and selling financial assets aimed at profit. decisions. A price chart is a sequence of prices displayed over a specific time period chosen by the trader:
Cryptocurrency charts rely on two crucial axes to represent price movements:
- X-Axis (Horizontal): This axis represents time. Each price bar or candlestick is positioned at a specific point along the X-axis depending on the chosen time frame (minutes, hours, days, etc.). By following the X-axis from left to right, you can visualize the chronological sequence of price movements.
- Y-Axis (Vertical): This axis represents price. The scale on the Y-axis depicts the range of prices the cryptocurrency has traded within during the chosen time frame. Each price point displayed on the chart corresponds to a specific value on the Y-axis scale.
Types of Charts
There are several types of price charts, but the 3 most common and basic forms of price chart are:
- Line Chart
- Bar Chart
- Candlestick Chart
In a line chart, each point on the graph represents a price. In a bar chart, each bar on the chart has a base and a top. These represent the lowest and highest prices reached within the specific time interval.
Candlestick charts are the most popular way to visualize price movements on a chart. Each candle represents price activity within a single timeframe, like an hour or a day. On an hourly chart, each candle shows the price action for 60 minutes, while on a 4-hour chart, each candle reflects the price activity over the past 4 hours.
Technical analysis using candlestick charts is often considered more intuitive than using basic bar charts. The visual elements of candlesticks provide traders with clearer signals and patterns to identify potential trading opportunities.
Candlesticks offer a wealth of information packed into a single bar. In fact in a candlestick chart, each element of the candle has a precise meaning. Let’s see them.
The Parts of a Candle
- High: The highest price reached during the timeframe (represented by the top wick of the candle).
- Low: The lowest price reached during the timeframe (represented by the bottom wick of the candle).
Open: The opening price for the timeframe is typically shown as a small horizontal line located at the top of the body if the opening price was higher than the closing price (upward movement), or at the bottom of the body if the opening price was lower than the closing price (downward movement). - Close: The closing price for the timeframe is also represented by a small horizontal line located at the top of the body if the closing price was higher than the opening price (upward movement), or at the bottom of the body if the closing price was lower than the opening price (downward movement).
- Body: The thick central part of the candle. It represents the difference between the opening and closing price for a specific timeframe.
Candlestick Colors
The color of the body indicates the relationship between the open and close price. While the colors used for candlesticks can vary depending on the charting platform, the most common options are:
- White/Black: This is the defaultDefault The inability to repay debts that causes bankruptcy. color scheme for many platforms. A white body indicates a closing price higher than the opening price (upward movement), while a black body indicates a closing price lower than the opening price (downward movement).
- Green/Red: Another popular scheme. Here, a green body represents an upward movement (close higher than open), and a red body represents a downward movement (close lower than open).
Regardless of the specific colors used, the key takeaway is that the body color provides a quick visual cue to identify whether the price closed higher or lower within the timeframe:
- BullishBull Market A market where prices are rising or expected to rise. (Opposite of Bear Market). white (or green) real body: The close is higher than the open. A white (or green) real body is bullish, and the longer the body, the more bullish it is. A long candlestick indicates that the close was far above the open, implying aggressive buying. In the daily battle of bulls and bears, the bulls won.
- BearishBear Market A market where prices are declining or expected to decline. (Opposite of Bull Market). black (or red) real body: The close is lower than the open. A black (or red) real body is bearish, and the longer the body, the more bearish it is. A long black candlestick indicates a preponderance of sellers throughout the session. In the daily battle of bulls and bears, the bears won.
This makes candlestick charts much easier to read and interpret compared to standard bar charts.
Candlestick with No Body: the Doji
A doji is a candlestick chart pattern characterized by an almost equal opening and closing price. This creates a small body, often appearing as a cross or plus sign on the chart. The name “doji” comes from the Japanese word meaning “the same thing,” reflecting the close proximity of the opening and closing prices.
Doji themselves are not inherently bullish or bearish, but rather represent a period of indecision between buyers and sellers, indicating a transitional phase in market sentiment. However Doji can sometimes signal potential trend reversals, especially when appearing after a strong price movement in either direction.
While all doji share the characteristic of close opening and closing prices, there are variations based on the length of their upper and lower shadows (wicks):
- Gravestone Doji: Small body with short upper shadow and long lower shadow, resembling a tombstone.
- Long-Legged Doji (also known as Plain Doji): A small body with very long upper and lower shadows, resembling a cross or plus sign. This pattern indicates significant buying and selling pressure within the timeframe, resulting in an almost equal opening and closing price.
- Dragonfly Doji: Small body with short lower shadow and long upper shadow, resembling a dragonfly.
How to Interpret Doji
The meaning of a doji depends heavily on the preceding price action and the overall market trend. Here’s a more detailed explanation of how doji interpretations are heavily influenced by preceding price movements and the overall market trend:
Preceding Price Movements:
- Trend Continuation: A doji appearing after a strong uptrend might indicate a pause or hesitation before further upward movement. Conversely, a doji following a strong downtrend could suggest a temporary halt before the downtrend continues.
- Trend Reversal: A doji appearing at the peak of an uptrend or the bottom of a downtrend can be a potential signal of a trend reversal. This is especially true if the doji is accompanied by high trading volumeVolume The amount of money or cryptocurrency exchanged over a specific period of time., suggesting a shift in buying and selling pressure.
- Consolidation: Doji patterns often occur during consolidation phases, where the price fluctuates within a specific range without a clear directional bias.
Overall Market Trend:
- Bullish Market: In a bullish market, a doji might indicate a temporary pause before the uptrend resumes. However, a series of doji patterns could also suggest a weakening of the bullish momentum.
- Bearish Market: In a bearish market, a doji might signal a brief interruption in the downtrend before it continues. Conversely, multiple doji patterns could indicate a potential bottom formation.
Volume matters too: A doji with high trading volume following a strong trend carries more weight in signaling a potential reversal compared to a doji with low volume. High volume suggests increased buying or selling pressure, potentially leading to a stronger shift in market sentiment.
Remember: Doji are not a guaranteed indicator of future price movements. The cryptocurrency market remains unpredictable, and unforeseen events can disrupt even well-analyzed patterns. Always incorporate technical analysis with other strategies and sound risk management practices.
Time Frames: Tailoring Your View
The time frame you choose determines the level of detail you see. Day traders, who open and close positions within a single trading day, typically focus on shorter timeframes like 5-minute or 15-minute charts to analyze price movements. In contrast, long-term investors, who hold positions for extended periods, prefer to analyze broader trends using hourly, 4-hour, daily, or even weekly charts. We can summarize the time frames in this way:
- Short-Term (Minutes, Hours): Ideal for day traders seeking to capitalize on rapid price movements. However, the abundance of data can be overwhelming and lead to impulsive decisions.
- Mid-Term (Hourly, 4-hour): Offers a balance between short-term noise and long-term trends, suitable for swing traders holding positions for a few hours to days.
- Long-Term (Daily, Weekly, Monthly): Provides a broader perspective on price movements, valuable for identifying long-term trends. These are suited for investors and position traders holding positions for extended periods.
Volume: Decoding Trading Activity
Many charts include a volume indicator, typically below the price chart. This represents the total amount of cryptocurrency traded during each time interval. High volume can indicate increased buying or selling pressure, potentially leading to stronger price movements.
Disclaimer: Technical analysis is a valuable tool that can help traders identify potential trading opportunities and manage risk. However, it is essential to remember that the cryptocurrency market remains inherently unpredictable, and unforeseen events can significantly impact price movements. Therefore, it is crucial to use technical analysis in conjunction with other strategies, such as fundamental analysis and sound risk management practices, to make informed trading decisions.