What is Technical Analysis?

Technical analysis is one of the methods used to predict prices in financial markets, based on historical data and price patterns. In this approach, various charts and tools are utilized to analyze price behavior and forecast future trends. Technical analysis is grounded in the hypothesis that all necessary information for predicting prices is embedded in past price data and trading volumes. In this article, we aim to provide an overview of technical analysis, its importance in cryptocurrency markets, examine its fundamental concepts, and introduce the different methods of technical analysis.

History of Technical Analysis

Technical analysis, as one of the key and fundamental methods for analyzing financial markets, has a long and intricate history that dates back hundreds of years. Over time, with the advancement of technology and financial sciences, this method has evolved into its modern form.

Japan and Candlestick Charts

Modern technical analysis began in Japan in the 17th century. Munehisa Homma, a Japanese rice trader, was one of the first individuals to seriously study price patterns and the impact of market psychology on prices. By using price data and patterns, he developed a method for predicting the price of rice, which today is known as candlestick charts. These charts gradually gained global recognition and have become one of the fundamental tools in technical analysis.

Charles Dow and Dow Theory

The Dow Theory, recognized as one of the foundations of technical analysis, was introduced by Charles Dow, the founder of The Wall Street Journal and the Dow Jones Industrial Average. This theory is based on principles that are still used as the foundation of technical analysis today. The main principles of Dow Theory include:

Everything is Reflected in the Price

This principle is based on the assumption that the market price reflects all available information. All economic, political, and psychological factors that might affect the price are reflected in the current price. In other words, the market automatically takes all available information into account in prices.

The Market Has Three Types of Trends:

According to Dow Theory, markets move in three types of trends:

1. Primary Trend: This is a long-term trend that can last for years and indicates the overall direction of the market (upward, downward, or sideways).

2. Secondary Trend:  This trend is known as a correction or retracement against the primary trend and usually lasts from a few weeks to several months. These trends can correct 33% to 66% of the primary trend's movement.

3. Minor Trend: These short-term trends typically last less than three weeks and represent small fluctuations within secondary trends.

Trends Form in Three Phases:

Market trends are composed of three phases:

1. Accumulation Phase: In this phase, informed and professional investors who recognize a shift in the overall market trend start buying or selling assets. This phase is usually characterized by low trading volume and slight price fluctuations.

2. Public Participation Phase: During this phase, the general public and traders become aware of the trend change and enter the market. The trend accelerates here, and trading volume increases.

3. Distribution Phase: In this phase, professional investors begin to sell their assets and exit the market, while the general public remains involved. This phase is usually indicative of the end of the trend and the beginning of a reversal.

Market Averages Must Confirm Each Other:

According to Dow Theory, for a trend to be confirmed, all major market indices (such as stock, commodity, and currency indices) must move in the same direction to produce a valid signal. For example, if the Dow Jones Industrial Average reaches a new peak, another index must reach a similar peak to confirm that the trend is upward. However, if the Dow Jones indicates the start of a new upward trend but another index remains in a downward trend, traders should assume that the new trend has not yet begun.

Trading Volume Must Confirm the Trend:

Trading volume should move in the direction of the trend. This means that in an upward trend, trading volume should increase, and in downward trends, trading volume should decrease. Typically, when the price moves in the direction of the primary trend, an increase in trading volume confirms this trend and indicates the entry of smart money into the market. Conversely, a decrease in volume during an upward trend may signal trader hesitation and the potential for a trend reversal. During pullbacks (temporary price retracements toward the moving average or support level), trading volume can provide important insights. An increase in volume during bullish pullbacks suggests buyer strength and the continuation of the upward trend, while an increase in volume during bearish pullbacks may indicate the weakening of the upward trend and the potential for a reversal. A decline in volume in a strong upward trend can serve as an early warning of a possible trend change. Similarly, an increase in volume in a downward trend can indicate the strength of sellers and the continuation of the downward trend.

Trends Continue Until Clear Signals Emerge

Dow Theory asserts that a trend (whether upward or downward) will continue until clear signals for its reversal appear. Distinguishing between a temporary pullback and a major trend reversal is one of the most challenging aspects of technical analysis. This is where the importance of the sixth principle of Dow Theory, "trends persist until a reversal signal is evident," becomes more apparent. Short-term fluctuations and unexpected events can create deceptive patterns, making it difficult to identify the primary trend. Sometimes, pullbacks are so deep that they resemble a trend reversal. Comparing the behavior of several different indicators (such as price indices, volume, and technical indicators) can help us confirm the validity of a trend reversal signal.

Expansion and Development of Technical Analysis in the 20th Century

In the 20th century, technical analysis gained broader attention, and with the advent of computers and analytical software, new tools and techniques were introduced to the field. Prominent figures like Richard Schabacker, Ralph Nelson Elliott, and William Gann contributed to the development and promotion of technical analysis.

Ralph Nelson Elliott introduced the Elliott Wave Theory, one of the most important theories in technical analysis. This theory is based on the premise that markets move in wave patterns that repeat themselves continuously.

William Gann also made a significant impact on technical analysis with tools such as Gann angles and Gann grids. He studied the relationship between price and time, believing that these relationships could be used to predict price reversal points.

Application of Technical Analysis in Cryptocurrencies

Cryptocurrencies, due to their high volatility, require precise and continuous analysis. In this context, technical analysis is one of the most popular and widely used tools among cryptocurrency traders. Some of the applications of technical analysis in the cryptocurrency market include:

Predicting Market Trends: By using technical tools and indicators, one can identify upward or downward trends in cryptocurrencies and make trading decisions based on them.

Identifying Entry and Exit Points: Technical analysis helps traders identify the best points to enter the market (buy) or exit the market (sell). These points are usually near support and resistance levels or after confirming specific price patterns.

Risk Management: Through technical analysis, it is possible to identify risky areas of the market and adjust risk management strategies accordingly. For example, using stop-loss orders in trades is one application of risk management.

 Analyzing Market Sentiment: Many indicators, such as RSI and MACD, provide information about overbought or oversold conditions in the market, which can help traders avoid emotional behavior and make more rational decisions.

Advantages and Disadvantages of Technical Analysis

Advantages:

1. Easy Access: Technical analysis tools and data are readily available, allowing traders to use them without needing complex resources.

2. Speed in Decision-Making: Because technical analysis relies on past data and analytical tools, it helps traders make trading decisions more quickly.

Flexibility: Technical analysis can be applied across all markets (stocks, currencies, commodities, and cryptocurrencies).

Disadvantages:

Uncertainty: Technical analysis does not guarantee accurate price predictions and is always accompanied by some degree of uncertainty.

Psychological Impact: Traders may rely too heavily on technical analysis and overlook fundamental analysis, which depends on economic factors and news.

False Signals: Indicators and price patterns may sometimes provide incorrect signals, which can lead to financial losses.

Conclusion:

Technical analysis is an important and essential tool for cryptocurrency traders, helping them predict future market trends and make better trading decisions using historical data and analytical tools. However, success in using technical analysis requires practice, experience, and combining it with other analytical methods, such as fundamental analysis.