Two basic principles of technical analysis: candlestick patterns and support/resistance levels

Learn to trade using support and resistance levels. We explore top strategies to pinpoint market direction and to time entry and exit points.

A brief guide to candlestick patterns, chart formations and support/resistance levels in cryptocurrency trading.

Jumps in Bitcoin price sometimes do not lend themselves to any logic. Everyone who has invested money in cryptocurrency or plans to do so wants to know what to expect next. There are several ways to predict future in crypto trading — to increase your chances of success it is really useful to know some basics of technical analysis.

Anatomy of crypto charts

In technical analysis, the chart is a fundamental element. Charts represent a display of price changes over a certain period of time. The most popular chart structures among crypto traders are Japanese candlestick charts, linear charts, and histogram (bars) charts. The candlestick chart is the most popular option out of these so we will explain it in more detail.

Candlestick charts is a type of financial chart that shows the price movements of an asset over a certain period of time. As the name implies, it consists of candlesticks, each of which represents the same amount of time. Candlesticks can represent almost any period, from seconds to several years.

The appearance of candlestick charts dates back to the 17th century. Their creation, as a tool for drawing charts, is often attributed to a Japanese rice trader named Homma. His ideas served as the basis for modern charts, they have been improved several times, before Charles Dow became one of the fathers of modern technical analysis.

Candlesticks can be used to analyze different types of data, but they are mainly designed to facilitate the perception of price changes in financial markets. When used correctly, this tool can help traders to correctly assess the potential for price fluctuations. They allow traders and investors to form their own ideas based on their market analysis.

How do candlesticks work?

The candlestick provides information on four factors for a given time period: the opening and closing price, the maximum and minimum price.

Opening/closing points are the price of an asset at the time of start/closing of a trade within a certain time period (1 minute, 5 minutes, hour, etc.). Minimum/maximum is the lowest and highest price of an asset during this time.

It is easy to find all four points on a candlestick — just define its body and shadows.

• The body is the wide middle part of the figure, most often painted in green or red. In the first case the candle is bullish, and in the second case it is bearish;
• The opening price is in the lower part of the body of a green candle and in the upper part of a red candle;
• The closing price is located in the upper part of a green candle and in the lower part of a red candle;
• The minimum and maximum prices are the same for both types of candlesticks, they are located at the ends of the thin lines that go out on both sides of the body.

A combination of these designations is often called OHLC (Greek for Open-high-low-close chart). The ratio between opening, maximum, minimum and closing determines the type of candlestick.

Again, let’s explain things in more detail. The distance between opening and closing is called the body, and the distance between the body and the maximum/minimum is called the wick or shadow. The distance between the maximum and minimum of a candle is called the range of a candle.

How to read candlesticks patterns?

Many traders believe that candlesticks are easier to read, unlike histograms or linear charts, although they provide similar information. Candlesticks are readable at a glance, so they offer us an easy to understand display of price movements.

In practice, candlesticks project resistance between bulls and bears on a certain timeframe. As a rule, the longer the body, the stronger was the pressure of buying or selling. If candlestick wicks are short, it means that the maximum (or minimum) of this timeframe was near the close price.

The color and settings may vary depending on the chart tools, but mostly if the body is green, the asset closed above the opening price. Red color means that the price moved down during the timeframe, and the candlestick closed below the open price.

Some traders prefer to use black and white. Thus, instead of using green and red, the charts represent upward movements in the form of hollow candlesticks and downward movements in the form of completely black candlesticks.

The most popular candlestick patterns

The volatility of cryptocurrency market is so high that the original appearance of candlesticks can change very quickly. Therefore, conclusions should be drawn only on the basis of already closed candlesticks.

Over time, traders have noticed that under certain conditions, a combination of similar formations is repeated on the asset chart. The three most frequent patterns even got their names: doji, the hammer and a shooting star.

Doji

The Doji is a perfect example of the indecision of most market players. In this case, the closing price coincides with the opening price, and the body of the candle turns into a thin line. In this case, the shadows can be either long or as short as possible.

If doji is formed after a series of green candlesticks — this is the first signal to the accumulation of an asset. The picture on the chart can be interpreted as follows: the bulls were pushing the price up all the time, but in the end the bears managed to equalize the forces. It’s time to pay attention to the nearest support levels and technical indicators.

The Hammer

The Hammer is a great opportunity for bulls to make money on change of a bearish trend. The characteristic shape of the candlestick shows that from the very beginning, the price fell well below the opening, but then returned its positions. Most often in such situations, a strong buyer appears, who can turn the price movement.

You can recognize the Hammer by four criteria:

• The length of the lower shadow is two to three times the length of the body;
• The upper shadow is very short or absent;
• The body of the candlestick is at the lowest point of the local trend;
• The body color is not important.

Shooting Star

This candlestick opens with a window upwards, has a short body and a long upper shadow. The shooting star is a bearish figure, i.e. it foreshadows the fall of cryptocurrency price.

The shooting star consists of only one candlestick, it is easy to determine it on the chart: you just need to check it by several criteria. If all criteria are the same, then the figure is real and the probability of the price falling will increase significantly.

First, it should be noted that there should be at least a short term growth of several candlesticks before the pattern formation. Then, if a candlestick meets all the above criteria, we refer it to the Shooting Star and draw the appropriate conclusions:

• The opening of the candlestick happened with a break upwards;
• The body of the candlestick is relatively short (it should visually look like a square);
• Candlestick is at least twice as long as the body;
• The lower shade is either absent or less than half the body height;
• Candlestick color does not matter.

All these attributes must be present in the figure of Shooting Star.

Important lines on the chart

Imagine that an elastic ball was thrown inside the house. There are two barriers that limit its flight and fall — the floor and the ceiling. In trading, there are similar barriers, which are called support and resistance. They limit the price movement of the asset and serve as the most popular tool for any trader.

Support and resistance can chart the price of a cryptocurrency for months. In traditional markets there are global levels from which the price bounces for years.

The beauty of these lines is that they are used by the vast majority of traders, which means that certain levels can be safely used as entry points for trade operations.

Support vs. Resistance

Why does price almost always bounce off support? The line on the chart has a quite sensible interpretation. Each buyer has its own value at which it considers an asset underestimated. Every trader is looking for good entry points based on his experience. If the price has bounced back from a certain level before, it means that this level has become acceptable for most buyers.

New players will find support as a good entry point and the price will bounce again. Concentration of orders at a certain level will increase the “strength” of support, preventing possible price collapse below.

On the other hand, the maximum points on the chart form a serious psychological level of the “ceiling”. If the asset cannot break through the resistance for a long time, it is very dangerous to open long positions at this level.

As with the support, the pressure of sellers on a certain line creates a barrier, through which it is difficult for the price to break through. The more pullbacks from the resistance, the stronger it is.

Horizontal support and resistance levels

The main rule for defining key levels is that they are not just lines. On the chart you can sometimes see fake breaks of support or resistance — it is a good trap for bears and bulls. Inexperienced traders open a position on the first breakout and immediately fall into the trap.

To avoid this, consider support or resistance as a certain area, not just a line. It is also recommended to find key levels on a line chart, which takes into account only the closing price of the asset.

So, how to determine support or resistance? Let’s consider a 1-day Monero/Dollar chart as an example. The asset broke through one global support level and rushed to the new one. The second level holds the price for now.

And now resistance on the 1-day Monero/Bitcoin chart. First, the price bounced off the first level twice, and then it bounced off the second one twice more.

For the price movement regarding support or resistance, this rules are fair:

• When price passes through resistance, this level can turn into support;
• The more frequently the price tests a certain area, the stronger is the pressure of buyers/sellers there;
• When support/resistance is broken through, the strength of the subsequent price movement depends on the strength of the level;
• The strength of the support/resistance depends on the time period. The lines on the daily chart are more reliable than the lines on the 1-hour chart.

Identifying key support/resistance levels comes with experience. Do not forget that there are not only horizontal levels, but also trend lines.

How to find a trend line on the chart?

Unfortunately, some traders do not know how to correctly define the asset trend. To find the support/resistance trend line it is enough to find local minimums/maximums of the price.

In case of growth, the trendline connects the lower points.

In case of a fall, it connects the upper points.

To draw a trend line, it is enough to find 2 points. However, only the trend line, which is in contact with the price chart in three points, can be considered valid.

Trend lines have their own characteristics:

• The steeper the angle of the trend line, the less reliable it will be in the future;
• The more the price touches the trend line, the stronger the price will jump or fall after its breakthrough;
• The longer the trend line (on longer timeframes), the more reliable it is.

It is noteworthy that the price does not necessarily move up or down. After significant declines, the accumulation stage often begins, which is characterized by a sideways movement. It is worst suited for trading. You can see it in detail by looking at the Bitcoin chart below.

As you can see, there are no visible signs of the upcoming price movement on the chart.

As with the horizontal support/resistance, you should not try to forcefully adjust the trendline to the price movement. To avoid false breakdowns of the trendline, build it on a linear chart or candlestick shadows.

How to use support and resistance levels?

There are two simplest strategies for trading with trend lines and horizontal support/resistance levels — bounce and breakout.

The first one involves opening a long position after confirming the bounce from the support line. Why not place an order in the support area itself? Nobody knows if the line will hold this wave of drain. And although this way you can get more profit, this strategy is likely to end up losing your entire deposit.

If the price still rushes down after the rebound, the loss from the failed transaction will be blocked by the stop-loss order.

It is a bit harder to trade a breakout. Here you can already use two methods — aggressive and conservative. The first one implies opening a short/long position immediately after a support or resistance breakthrough.

Why does this method sometimes not work? The fact is that after the breakout of the resistance and support, very often there is a price pullback, which tests the line again. Sometimes this pullback can lead to another trap, which forces the trader to close the position in the minus.

https://www.dropbox.com/s/n9dsp17jx10fqgt/8sp.webp?dl=0

The conservative way implies opening a position after a rollback to the resistance/support level. If the price, having tested the line, bounces off it again, a trade can bring a good profit with minimal risk.

Now you have some of the basic principles to successfully trade Bitcoin and other cryptocurrencies. Of course, it is just a beginning of a journey to more complex trader tools in technical analysis. And remember — you need something to trade and learn. Make your first BTC with our Bitcoin cloud mining platform Hashmart.io!