Knowing how to read crypto charts is a crucial skill for any cryptocurrency trader. The ability to correctly spot trading chart patterns such as trends and momentum is what distinguishes a successful trader from a non-successful trader.
Technical and Fundamental Analysis
Chart reading skills are part of the overall technical analysis. Technical analysis refers to a set of analysis methods that help derive forecasts from trading charts based on the past performance of the chart indicators. Typical indicators charted for technical analysis include financial asset prices, moving averages, and trend lines.
What is Technical Analysis?
Technical analysis assumes that the analyzed charts include all the necessary information to make conclusions about the chart lines’ future movements. This is a bold assumption that many industry analysts have questioned. These analysts believe that technical analysis of price charts is not sufficient to make firm conclusions based solely on the available quantitative data and that technical analysis should be complemented with fundamental analysis.
What is Fundamental Analysis?
Fundamental analysis refers to the study of qualitative data such as industry news, corporate announcements, government action, international affairs, legislative changes, consumer sentiment surveys, and more. This type of data is different from hard quantitative data such as past asset prices and moving averages.
In the context of cryptocurrency trading, fundamental analysis pieces may include information such as ICOs, crypto platform news on social media, news on new funding obtained by a platform, news on hacks and security breaches, laws introduced by governments to regulate crypto, and so on. For a savvy crypto trader, it is important to supplement reading crypto charts with fundamental analysis sources.
What to Pay Attention to When Reading Crypto Charts
Two critical pieces of information that a trader should look for when analyzing crypto charts are trend and momentum. For most traders, being able to correctly spot trends and momentum provides enough basis for successful long-term trading.
What is Trend Trading?
A trend is an upward or downward pattern in a chart that typically lasts from a few days to many months, or in some cases, even years. When the price chart shows an upward movement pattern, it is called an uptrend. Conversely, the declining price pattern is called a downtrend.
Examples of an uptrend and a downtrend (Source: StackOverflow.com)
The ability to spot emerging trends and identify when a particular trend is about to break is the essence of trend analysis.
Long-term trends applicable to the entire market, i.e., most assets traded on it, that last a few months or more often establish bear and bull markets. Bull markets emerge when an uptrend of long-term nature persists, while, in turn, bear markets are those with a longer-term market-wide downtrend.
Market-wide trends, and the bear or bull markets they cause, have particular relevance to the cryptocurrency market, with its heavy reliance on Bitcoin (BTC) and, to a lesser degree, Ethereum (ETH) price movements. Unlike the stock market, which has a wide variety of stocks that individually do not have significant power to affect the entire market, the crypto market’s reliance on the BTC and ETH pair causes market-wide trends when one or both of these coins move in a particular direction.
The overall cryptocurrency market capitalization (Source: adapted from Tradingview.com)
The chart above shows two significant bear and bull markets. The 2018 bear market was a year-long downtrend. The raging bull market (highlighted in green) started in early March 2020 and lasted until the end of March 2021, after which the market experienced a massive crash.
The long-term obvious trends, such as the two shown in the chart above, contain within them many small market events, such as corrections and upswings. However, these smaller events do not break the overall direction/pattern in the chart.
Just as we are able to classify the two big chart movements above as trends, we can also classify similar but much shorter movements as trends as long as the overall pattern of movement persists for at least a few days.
What is Momentum Trading?
Momentum is another important chart reading in addition to trend. It is closely related to trend and refers to the speed of the price changes during a trend.
Momentum is a measure of the trend’s “force” or intensity. You may think of it as the primary measure of a trend’s strength. Momentum has a pretty simple formula used to measure it.
Momentum = Current price – Price X days ago * X
A typical time interval for momentum measurement, i.e., the number for X in the formula above, is 10 days. However, you may use other time intervals depending on the duration of the trend being analyzed.
The value for momentum is a positive or negative number that you plot on the chart for momentum measures over a number of periods. A positive momentum number indicates a strong enough trend that is likely to persist. A negative momentum number, on the other hand, indicates that a trend may be about to break.
A chart showing asset price with the momentum measure below (Source: Commodity.com)
What are Some Useful Methods to Analyze Crypto Charts?
Trend and momentum are the fundamental chart “events” that a good trader should track. However, identifying, tracking, and analyzing these events is not done with only a mere observation of the chart. Simple chart observation will only tell you about past events but will not help you forecast future developments.
A number of technical analysis methods are used to analyze and predict future chart movements. Naturally, none of these methods are going to give you 100% assurance, and they may often fail to inform you of the right course of action. However, applied consistently over time, they are very useful for crypto asset price analysis.
The most fundamental of these methods are:
- The simple moving average (SMA)
- The exponential moving average (EMA)
- Moving average convergence-divergence (MACD)
- The relative strength index (RSI)
The simple moving average (SMA)
The simple moving average (SMA) is the simplest, and at the same time, very informative measure to track trends. It is a great measure to identify a potential break in the existing trend. The SMA is calculated as the average of prices over a number of measurement periods, typically days, and is added to the price chart.
SMA’s for three periods added to the price chart (Source: BabyPips.com)
In the image above, three different SMAs, 5-,30-, and 62-day, are added to the asset price chart. The longer the period covered by an SMA, the more “smoothed out” its line will look on the chart.
The SMA helps you see the overall trend in the price chart without the distraction of smaller events that occur within the trend but do not break it.
The exponential moving average (EMA)
The exponential moving average (EMA) is a modification of the SMA which gives higher weight to the later data points used for calculating the average.
The EMA is believed to be more sensitive to potential changes in the price chart due to this weighting modification. The actual weighting procedure is determined by the analyst depending on the goals of the analysis.
The MACD Indicator
The moving average convergence-divergence is a more complex modification to the SMA and EMA. The MACD chart shows two lines. The first line is a set of values calculated by subtracting the asset’s 26-period EMA from its 12-period EMA. This is the main MACD line.
The second line is the 9-period of the MACD values. It is called the signal line. When the MACD line crosses the signal line, it indicates potential emergence or a break in a trend.
The MACD line and signal line shown below the asset price chart (Source: AMarkets.com)
The RSI Indicator
In the previous section, we showed the formula for the momentum measure and how it may be interpreted depending on the sign of the measure. However, this basic momentum measure is often not adequate for more involved price chart analysis.
A preferred measure to identify momentum is the relative strength index (RSI). The RSI has a more complex calculation than the simple momentum measure and is normally derived using financial analysis software.
The RSI is always a value between 0 and 100. An RSI larger than 70 indicates that the asset is likely to correct. Conversely, an RSI under 30 points to an asset that is about to start rising.
The RSI chart shown under the asset price chart (Source: Steema.com)
Analyzing crypto asset price charts is a useful skill for any trader interested in the cryptocurrency market. Along with the analysis based on only the chart events, i.e., technical analysis, it is important to take into account various fundamental analysis sources.
When analyzing crypto charts, there are two overarching chart movement concepts to look for – trend and momentum. Trends establish the direction of the pattern in charts, while momentum indicate the strength of these patterns.
Trend and momentum analysis and tracking are not done by simple visual observation, at least not by any serious trader. There are many technical analysis techniques used for spotting and following trends and momentum. The total number of the techniques is extremely wide and covers the entire spectrum of technical analysis.
However, the most fundamental among these techniques you may concentrate for basic chart reading and interpretation are SMA, EMA, MACD, and RSI.