Technical Analysis

Technical analysis is the analysis of financial markets from the point of view of past data. In other words, technical analysis aims to prescribe in which direction the price of a given asset is more likely to move given the way this asset trades now and has traded in the past.

In the most classic formulation, technical analysis can be understood as the analysis of assets based on the historical price and volume data. With such an approach, we look at how the price of an asset has evolved, how this fits in with the past price patterns and we do the same for volume. The main assumptions of this incarnation of technical analysis are that the price and volume data reflect all, or at least most of the information relevant to investors, and that specific price/volume patterns tend to repeat themselves in time.

A very straightforward example of such an approach could be described as follows: suppose we have an asset X and we look at its price in order to get an idea if X could trade higher or lower on the next day. We notice that currently X has appreciated for seven days in a row. This is the current situation. We then go and look at all the historical prices of X and search for the situations in which X appreciated for seven days straight. We collect the data for all these situations similar to the current one and look at what happened in these situations on the eighth day. Suppose that we find that in an overwhelming majority of the cases, say 90%, the eighth day is a day of strong appreciation. We then could conclude, based on the assumption that patterns tend to repeat themselves in time, that the next day in the current case is also more likely to be a day of strong appreciation than not.

In reality, rarely do we get such a clear picture. Usually, we don’t limit ourselves to the price, but rather consider volume as well. The patterns in the market can also be a lot more complicated than the simple one described above. Also, some formulations of technical analysis allow one to look at data from different assets, different markets, or even they go beyond classic price/volume considerations and incorporate other sources of data. Some of the most popular technical analysis tools are, among others, support and resistance levels, trends, the analysis of volume, the RSI. This is by no means an exhaustive list and we use a lot more tools, some developed in-house, in our investment analyses.

Gold Pricing vs. Gold Valuation

Why would we want to turn to technical analysis when investing in gold and trading the yellow metal? Why not rely solely on fundamental analysis? Let’s break this down. Gold is neither a cash-generating asset nor a commodity. It means that gold cannot be valued like assets which generate cash flows or even as commodities whose value can at least be estimated looking at the balance of demand and supply. The yellow metal has no intrinsic value, but only a relative one (currencies cannot be valued, but they can be priced against other currencies). Hence, gold investing is more like the pricing game, not the value game. There are no cash flows and industrial use is minuscule – so, we cannot determine the intrinsic value of gold, but what we can do is try to guess the future price direction, which is affected by market sentiment.

We are not saying that fundamentals don’t matter for the precious metals market. After all, the shifts in the market sentiment are not ‘deus ex machina’. People do not formulate their opinions in a void, but based on the observation of the changes in objective reality and fundamental drivers. What we are saying is that gold market fundamentals are substantially different than in the case of cash-generating assets or commodity markets. As gold is a currency (or an anti-fiat currency), the influence of these factors on gold prices occurs via investor’s perceptions and moods. And it is technical analysis that helps in the identification of repeating moods via recurring patterns. So, while fundamentals are certainly important, there are other arrows in the quiver, technical analysis being one of them.

Gold Technical Analysis

We will show an example of how technical analysis might be useful for gold traders and investors. To do this, we are going to use a little-known technique known as the triangle apex reversal. The main idea is to draw support and resistance lines and to look at the points where they cross over, creating a sort of triangle. Such points might be ones where reversals occur. We used this kind of analysis in our Gold & Silver Trading Alert on April 12th, 2018. Let’s take a look at the chart from this alert.

Gold - Continuous Contract

There were multiple support and resistance lines in the chart, and so there were multiple potential reversals – they are marked by vertical dashed lines. Based on the analysis of the reversal points, we concluded that gold reversed a bit after the triangle-apex-based reversal, but it was so close that the delay was almost impossible to notice without knowing that there indeed was one. Gold reversed at its reversal – simple as that. What happened following this signal was quite remarkable.

Gold - Continuous Contract

We marked the following months on the chart above. Gold reversed as was expected. But it did more than that. It actually started a very powerful slide which would not end until months later. Technical analysis could have provided investors and traders with an indication as to the starting point of the decline.

Silver Technical Analysis

The white metal is also an asset traded in financial markets. We have historical data for it, so it can be subject to technical analysis. For silver, we will use the RSI, and a specific pattern in it as an example. Let’s take a look at the chart below.

Silver - Continuous Contract

On this chart, we see that the RSI displayed a curious pattern. In specific cases, there was an initial move to or above the 70 line on the RSI, followed by a move lower in the index and then another move higher, which topped above the level of 80 and was followed by a move lower in the RSI. This specific pattern in the RSI turned out to herald very significant long-term tops, the ones in 2004, 2006 and 2008. Was the next top also a subject to this pattern?

Silver - Continuous Contract

Yes, it was. So, using technical analysis to analyze the silver market, and in particular using this specific pattern in the RSI as a top indicator, could have been quite helpful to silver investors and traders, as silver went down massively in 2011 and actually ended the whole 2000/2001-2011 bull market almost exactly when the discussed signal was flashed.

Bitcoin Technical Analysis

Bitcoin is an asset with a lot more volatility to it than gold or silver. Can technical analysis still be used to analyze the digital currency? Let’s take a look at the chart for BitStamp.

Bitcoin BitStamp

The three lines we see on the above chart are the support levels based on several important local bottoms. The steepest line is based on the November 2017 and December 2017 local bottoms. The middle line is based on the September 2017 and November 2017 local bottoms. The bottom line is based on the September 2017 and February 2018 local lows. Now, the important part is that significant moves below these lines could have been read as bearish signs.

The breakdown below the first line was followed by a powerful extension of the declines from the $20,000 top. The second line was broken for the first time during this decline. Bitcoin returned above this line and tested it but when it decisively moved below it, this was followed by the continuation of the long-term decline. The third, lowest line, was an indication that more declines could follow. We did see a correction afterwards, but it did not even reach this line and, in the space of several months, more declines unfolded. So, even though Bitcoin is wildly volatile and using classic technical analysis tools might be more problematic than in the case of gold and silver, technical analysis can still provide investors and traders with signals.