Bitcoin offers investment and trading opportunities for those willing to take on the risk of the cryptocurrency’s frequent and significant swings in value. Because Bitcoin does not have underlying fundamentals such as with oil, coffee, gold, or your favorite stock, traders commonly use technical analysis indicators to guide their buying and selling decisions. Before deciding which technical indicators are best for trading Bitcoin a novice trader needs to become familiar with technical analysis and appreciate how its benefits and risks affect one’s trading.
What Is Technical Analysis
Technical analysis is the evaluation of specific historic price indicators derived from a market. This approach goes back hundreds of years to when Samurai were in charge in Japan. A trader in the rice market at that time recognized that certain price patterns had predictive value for what the market would do next. This approach is used even today by traders and is called Japan Candlesticks based on the candlestick-like symbols it uses. Today there are many types of systems for technical analysis, all of which a trader uses on their trade station and give useful clues as to what the market will do next based on its recent and current price performance. When the price of an asset such as Bitcoin is steadily going up will it continue or will it reverse and fall back? Traders use technical analysis tools to help make a determination of when to buy, when to sell and where to set price points for automatically taking a profit or limiting a loss.
Common Technical Analysis Tools
Frequently used technical indicators include the moving average, the moving average divergence convergence indicator, the RSI or relative strength index, the average directional index, trading volume, and Bollinger bands which are indicators of market volatility. Experienced traders typically use more than just one tool, often using one to guide them and another to confirm what the first one indicates. Moving averages are extremely useful in that they give an average of an asset’s price over time thus reducing the ”static” and confusion of very short term price swings. Volume indicators help traders appreciate when price movements up or down are momentary or likely to turn into a trend. Those who want to succeed in using technical analysis tools to profit in trading an asset like Bitcoin are well advised to learn how to use several basic technical tools like the ones we mentioned. Smart traders will practice simulation trading using real market data on their trade station until they can routinely “profit.” Common advice is never to risk your own money in technical analysis trading of Bitcoin or any other asset until you are routinely making “paper profits” in your simulation trading!
Technical Analysis Pitfalls When Trading Bitcoin
Technical analysis works best in markets with high trading volume because it is, at its heart, a statistical approach. Thus, using technical analysis to trade Bitcoin generally makes sense while using the approach for thinly traded alt coins does not. However, the issue of trading volume can carry significant risk with Bitcoin as well. This has to do with Bitcoin wash trading. Wash trading is when someone sells and buys an asset almost simultaneously so that the result is a “wash.” Historically stock traders would do this to take a tax loss on stock that they had purchased that had fallen in price and then buy again at a discount. The IRS does not allow stock traders to write off these losses so that practice is not used for stocks. However, it is common in trading Bitcoin where it is not illegal. The purpose in Bitcoin trading is to fool other traders into thinking that there is greater volume in a current price move than actually exists. Thus, a trader who is using a volume indicator to help determine how solid a market move is can be fooled into thinking that they are jumping into an upward trend only to lose money when the “trend” does not in fact exist.
Managing Risks in Bitcoin Trading
The first and most important step in managing risks in Bitcoin trading with technical analysis is to learn the tools well and never trade until you have mastered those tools in simulation trading. The next and equally important thing is to rely on technical tools while ignoring the hype that is so common regarding Bitcoin. All too often some “expert” predicts that Bitcoin will go up by a huge multiple in the next year. This is all too often hype by someone who has already purchased and is “pumping” Bitcoin with plans to “dump” or sell when the market goes up and before it corrects downward again.
A daily issue with risk management is to remember that with thousands of folks trading all at the same time prices can fluctuate significantly and very rapidly. Smart traders set trading stops with each and every trade, That is they place sell orders above the price at which they made a purchase and also below that price in order to lock in potential profits and limit potential losses.