Chapter 4. Fundamentals of technical analysis

What is a long position (purchase)?
A long position implies the purchase of an asset based on the growth of its value. Long positions are often used in the context of derivatives products and the foreign exchange market, but they are applicable to almost any asset class or market type. Buying an asset on the spot market in the hope of an increase in its price is also a long position.

Long positions on financial products are the most common way of investing, especially among beginners. Long-term trading strategies such as "buy and hold" are based on the assumption that the value of the underlying asset will rise. In this sense, "buy and hold" is just a long position held for a long time.

However, a long position does not necessarily mean that a trader hopes to make money on price growth. Take, for example, tokens with leverage. BTCDOWN is inversely correlated with the price of Bitcoin. When the price of Bitcoin rises, the price of BTCDOWN falls, and vice versa. In this sense, a long position on BTCDOWN means waiting for the bitcoin price to decline.

What is a short position (sale)?
A short position means selling an asset with the intention of buying it back later at a lower price. Short sales (shorting) are closely related to margin trading, as they can be carried out with borrowed assets. However, they are also common in derivatives markets, and a simple spot position can be used. How do short sales work?

A shot from the movie "The Game for a fall" (orig. title "The Big Short")
If we talk about short sales in spot markets, then everything is simple. Let's say you already have bitcoins and you expect the price to fall. You sell BTC for dollars to redeem later at a lower price. In this case, you are actually taking a short position on bitcoin, as you are selling at a high price to buy at a lower one.

But now consider the short sale of borrowed assets. You borrow an asset that, in your opinion, should become cheaper – for example, stocks or cryptocurrency. And you sell it right away. If everything goes according to plan and the asset price falls, then you buy back the same amount that you borrowed. You return the borrowed asset (together with interest) and earn on the difference between the price at which you initially sold and the one at which you bought the asset.

Consider an example of a short sale of borrowed bitcoins. You borrow 1 BTC, leaving the required collateral, and immediately sell for $10,000. Let's say the price drops to $8000. You buy 1 BTC and return it along with the interest. Since you sold bitcoin for $10,000 and bought back $8000, your profit is $2000 (minus interest and commissions).

What is a glass of orders?

Example of a glass of orders for the BTCUSD crypto currency pair
A glass of orders is a collection of current open orders for an asset sorted by price. When you place an application that is not executed instantly, it is added to the glass of applications. It remains there until it is executed by another application or canceled.

The bid stacks may look different on different platforms, but they mostly contain the same information, in particular the number of bids with a particular price.

If we talk about cryptocurrency exchanges and online trading, then applications in the glass are compared by an automatic system. This system ensures the conclusion of transactions, so it can be considered the brain of the exchange. Together with the glass of orders, this system forms the core of the electronic exchange.

What is the depth of the glass of orders?
The depth of the glass of orders (or the depth of the market) is called the visualization of current open orders in the glass. As a rule, it is presented in the form of a graph, where orders for purchase are placed on the one hand, and for sale on the other.

The depth of the order glass of the BTCUSDT currency pair on the Binance crypto exchange
In a broader sense, the depth of the glass of orders can also be called the volume of liquidity that can absorb the glass of orders. The "deeper" the market, the greater the liquidity of the order glass. In this sense, a more liquid market is able to absorb large orders without significantly affecting the price. But if the market is illiquid, then large orders can significantly affect the price.

What is a market order?
A market order is an order to buy or sell at the best available market price at the moment. In fact, this is the fastest way to enter or exit the market.

By placing a market bid, you are actually saying, "I want to execute this bid now at the best possible price."

Your market order will execute orders from the glass until it is fully executed. Therefore, large traders (whales) can significantly influence the price using market orders. A large order in the market can actually drain liquidity from the order glass. How? To answer, consider such a concept as sliding.

What is slippage in trading?
In connection with market applications, it is worth understanding what slippage is. When we say that a market order is executed at the best available price, it means that it executes comparable orders from the glass.

But what if there is not enough liquidity with the desired price to execute a market bid? There may be a big difference between the price at which you expect your request to be executed and the one at which it will actually be executed. And this difference is called slippage.

Let's say you want to open a long position on some altcoin for 10 BTC. However, this altcoin has a relatively small market capitalization, and it trades in a market with low liquidity. If you use a market order, it will execute orders from the glass for a total amount of 10 BTC. In a liquid market, you can execute an order for 10 BTC without significantly affecting the price. But in our case, insufficient liquidity means that there may not be enough sales orders in the glass in the current price range.

Therefore, at the time of the full execution of the order for 10 BTC, you may find that you have paid a higher average price than expected. In other words, due to a shortage of sales orders, your market order went up in the glass and coincided with orders with a higher price.

Consider slippage when trading altcoins, as some trading pairs may not have enough liquidity to execute your market orders.

What are limit orders?
A limit order is an order to buy or sell an asset at a given or better price. This price is called the limit price. Limit buy orders are executed at a limit or lower price, and sell orders are executed at a limit or higher price.

By placing a limit order, you are actually saying: "I want to execute this order at a given or better price, but not at the worst."

Limit orders give you more control over entering and exiting the market. They guarantee that your application will not be executed at a price worse than desired. However, there is a drawback here. The market may never reach your price, and your order will remain unfulfilled. This often means a lost transaction opportunity.

Each trader has his own criteria when to use a limit or market order. Some traders use only one type of order, while others use both, depending on the circumstances. It is important to understand how they work in order to make your choice.

What is a Stop Loss?
Now that we know what market and limit orders are, it's time to talk about stop losses. A stop loss is a limit or market order that is triggered only when an asset reaches a certain price. This price is called a stop price.

The main purpose of a stop loss is to limit losses. Each transaction must have an invalidity point in the form of a preset price. This is the level at which you acknowledge the failure of your original idea, which means that you must exit the market to avoid further losses. Thus, the point of invalidity is the price that is indicated in the Stop Loss.

How does a Stop loss work? As already mentioned, a stop loss can be both a limit and a market order. These options are called: limit stop loss (or stop limit) and market stop loss. The main thing to understand is that a stop loss is triggered only when a certain price (stop price) is reached. When the stop price is reached, either a market or a limit order is triggered.

But it is worth bearing in mind the following. We know that limit orders are executed only at the limit or best price, but not at the worst. If you use a limit Stop loss and the market collapses sharply, it can quickly move away from your limit price and your order will remain unfulfilled. In other words, the stop price activates the Stop Loss, but due to a sharp drop in the price, the limit order will remain unfulfilled. Therefore, market stop-losses are considered safer than limit ones. They guarantee that you will exit the market when you reach your point of invalidity, even in extreme market conditions.

Who are makers and takers?
You become a maker when you place an order that is not executed immediately, but is added to the glass. Since your order increases the liquidity of the glass, you are the "maker" of liquidity.

Limit orders are usually maker orders, but not in all cases. Let's say you place a limit order for a purchase at a price that is significantly higher than the current market price. Since your order can be executed at the limit or the best price, it will be executed at the market price (since it is lower than the limit).

You become a taker when you place an order that is executed immediately. Your order is not added to the glass, but is immediately executed by an existing order from the glass. You take the liquidity out of the glass, so you are a taker (take – take). Market orders are always takers, as they are executed at the best available market price.

Trend lines are widely used by traders and technical analysts. These are lines connecting certain points on the graph. As a rule, price charts are used, but not always. Some traders can also draw trend lines for technical indicators and oscillators.

The main idea of trend lines is to visualize certain aspects of price behavior. This allows traders to determine the overall trend and market structure.

Some traders may use trend lines only to better understand the market structure. Others can use them to formulate working trading ideas based on the interaction of trend lines with price.

Trend lines can be applied to charts depicting almost any time interval. But, as with other market analysis tools, long-term trend lines are usually more reliable than short-term ones.

Another aspect that deserves attention is the strength of the trend line. According to the generally accepted definition, a trend line is considered confirmed if the price touches it at least two or three times. As a rule, the more times the price has touched it (tested it), the more reliable the trend line is.

What is support and resistance?
Support and resistance belong to the basic concepts of trading and technical analysis.

support and resistance, chart, trend
The support level (red) is tested and breaks through, turning into resistance. Source: binance
Support is the level from which the price "pushes off". In other words, the support level is a zone of substantial demand, where buyers come into play and push the price up.

Resistance is the level where the price hits the "ceiling". The resistance level is a zone of substantial supply, where sellers come into play and push the price down.

Thus, support and resistance are levels of correspondingly increased supply and demand. However, when considering support and resistance, many other factors may play a role.

Potential support and resistance levels can also be indicated by technical indicators such as trend lines, moving averages, Bollinger bands, Ichimoku clouds and Fibonacci retracement levels. Even aspects of human psychology are used. Therefore, traders and investors can use support and resistance in their trading strategy in different ways.