Trading Cryptocurrencies. Does Technical Analysis Work For Cryptocurrencies? My Take On Trading Cryptos

Please make sure to read my foreword before proceeding and also read the full article before establishing an opinion about this article.

This article is my personal opinion and it’s not intended to be seen as any type of investment advice. It is purely for entertainment purposes. Trading any financial market is inherently risky and you have to make sure to understand the risk before making any decisions. (full risk disclaimer)

Introduction

My goal with the article is it to share my personal view, things that I have learned about the crypto market after following it for over 12 months, issues I see with other traders who contact me and I also want to provide my opinion on different aspects about the cryptocurrency market.

We will take a step by step look at the crypto price action, explore the new market, the players, talk about trading vs. investing, price discovery and more. If you are looking for specific buy or sell recommendations, this article is not for you. But if you want to get a different view without the hype and drama, chances are that you will enjoy this piece 😉

Crypto markets are new

Doh! You probably didn’t need me to tell you this, but let’s start at the beginning. And yes, although a bitcoin chart will date back to 2013, when it comes to mainstream attention, the crypto market is still a baby compared to other established financial markets.

The implications of this fact are manifold as we will see shortly. But what it basically means is that we are all exploring uncharted terrain and everyone is figuring out as we are going. The players in this market are new, many without any prior experience in financial markets. Regulators are trying to make up their minds, governments are dealing with the unknown and even the technical aspect is developing on the fly. I am not saying that this is bad (or good) but I am just stating the obvious so that we can lay the groundwork.

I find it very fascinating to witness the creation and the development of a new market right in front of our eyes. No one knows what will happen next month or next year with this new market and where this is going, but following it from an interest-driven perspective is fascinating to me. It also unveils a lot about how humans tick from a greed and fear perspective, how we are hard-wired and you can even learn a lot about yourself too. This is a very valuable lesson for anyone, regardless of whether you see yourself as a trader or just a “normal” person.

The players in the crypto market

Before we take a look at price charts and technical analysis, let’s see why the crypto market is so unique.

From what I am seeing, it seems that the composition of the people who are involved in trading the crypto market is unique.

First of all, many people are relatively tech-savvy because buying, storing and the technical side of the crypto market is often not as straight-forward as it is with other markets where you can just ring up your bank and have them buy any company stock for you or you open a broker account and buy/sell assets with just one click. The average Joe hasn’t gotten into the crypto market as much yet, although the mainstream media is pushing more and more people into it.

The players in the crypto market can be (very) broadly categorized. What they have in common though is their appetite for high variance.

One group of people who are interested in cryptos are below the average age of the typical investor in let’s say stocks or futures. The reasons for the demographic difference could be due to the tech side of things and that the newer generations are more open to new technologies. However, as other broker research has confirmed in the past, there could be another factor behind the unique composition of the crypto market:

“Poor, young men who live in urban areas and belong to specific minority groups invest more in stocks with lottery-type features. Investors with a large differential between their existing economic conditions and their aspiration levels hold riskier stocks in their portfolios.” (1) 

Another major group is made up of hedge funds, major (investment) banks and other big financial players. Those have a large appetite for variance and are betting, just like the first group, on a potentially huge return by being early adopters. However, this second group usually understands the risk associated with it much better and is more diversified. Plus, they have done their homework and know what they are getting into.

Finding your average investor or speculator is not as common yet. Entry barriers, price fluctuations anunderstandingunderstaning for this space are the main drivers. This unique composition of high-variance players is creating a unique set of financial actors.

The market is always changing

Because there are always new players coming into the market and many of the exchanges cannot even keep up with the flood of registrations, it also means that the composition of market participants is always changing.

What this does is that the dynamics of the markets are always changing as well. The more people with little to no prior trading experience are entering the market, the less predictable the price discovery could become. Volatility spikes can increase and the rally vs. sell-off dynamic (which we will cover later) changes all the time as well. Dips could potentially target the inexperienced participants and try to shake them out. Fakeouts and shakeouts are commonly known in other financial markets and they could also manifest in the crypto market.

Just a brief look at Bitcoin and Ethereum below with the ATR indicator (Average True Range – an indicator that measures price fluctuations) show how the price dynamic has changed. The rise in the blue ATR shows clearly how the price fluctiations have accelerated up until the point where the markets have topped for now.

Black swan events

The price discovery is driven by people who are buying and selling their cryptocurrencies and one contributing factor to how people make their buying/selling decisions are the so-called black swan events.

What is a black swan event?

The black swan is a term that describes unexpected and unforeseeable events which can cause major price fluctuations.

In the Forex market, the unpegging of the CHF, the BREXIT or the flash-crash were all so-called flash crash events. Those events can lead to major price movements within seconds where all the liquidity is sucked out of the markets and the price just tumbles for hundreds or even thousands of points.

Many people argue that black swan events could become more likely in the crypto market as well. Some reasons for such an argument are the increasing likelihood of government interventions and regulations. Add to that the unique composition of market participants and a knee-jerk sell-off reaction could easily turn into a large price drop. Especially now with the advent of crypto futures and CFDs it becomes even easier to express a short position. We have already seen one incidence in ETH during June 2017.

I am not a gloom and doom guy but I am just stating the obvious and something that many euphoria-driven, inexperienced crypto traders do not fully understand because they haven’t experienced such a black swan event in the past or a market cycle for that matter. This becomes especially dangerous if you are trading cryptocurrencies on margin which is a whole different story.

Cryptocurrencies and technical analysis

Now let’s finally dig into some charts. I have been looking at price charts, mainly Forex, for the past decade and charting is a huge passion of mine. I’d also say that I am relatively good at finding patterns and understanding price moves. I have been also following cryptocurrency price charts for over a year now to explore whether it is worth applying the concepts of technical analysis to those charts or stick to a buy and hold psychology.

Here are my observations to this date when it comes to technicals and price action for cryptocurrencies:

Round numbers

Round numbers, especially on the Bitcoin market seem to be working quite well. Round numbers can often have a psychological impact and other financial markets often show similar characteristics.

Of course, they do not work all the time, like any other tool of technical analysis, but it appears that the market participants are paying attention to them. One big contributing factor could be the exposure to financial news where Bitcoin gains popularity nearly every time a big round number is approaching. For inexperienced participants, those round numbers are also easily identifiable.

Breakouts

Before the increase in volatility and when the Bitcoin market used to be a pure bull market, up until reaching the top below 20,000 late 2017, breakouts were the way to go. Horizontal breakout buying seems to have worked very accurately but since the market has topped and been fluctuating more, this strategy is not as helpful anymore.

Support and resistance

Bitcoin is the largest crypto market with the highest market capitalization and the price has started to follow more conventional support and resistance concepts recently. It is far from being a perfect market but the fact that the price is paying more attention to those concepts seems promising. It is still not something I would trade actively like I do with Forex, but it sparked my interest more and I am keeping an eye on it.

However, this effect seems to be limited to Bitcoin mostly for now. Even the second and third largest cryptocurrencies are not there yet and their technicals do not look as accurate as Bitcoin does. Although you can see that the price does respect some levels some of the time, the accuracy goes down and also the steadier flow we are used to from looking at Forex, Futures or stocks charts cannot be compared. And once you start going down the list of cryptocurrencies, the effect becomes less and less visible.

Price dynamics – sell offs vs. rallies

One of the most important factors of charting cryptocurrencies is that the price seems to undergo different phases:

Greed – Fear – Loss of interest

Again, I am not saying that this is a truth set in stone, but I am sharing my personal view and the impressions I get from interacting with traders daily and paying close attention to the financial and mainstream media.

Whenever Bitcoin puts in a rally, it will be prominently featured on various financial media channels. When it dips, the fear mongers come out and predict the next big drop or even the end of crypto for good. And during periods of sideways movements, people lose the interest for a while. This phenomenon confirms, at least for me, my hypothesis from above that the composition of the crypto markets is unique and inherently different from other established markets.

Again, as a person who has been involved in financial markets since I was 15 this is fascinating to watch and it helps you understand human psychology and motives in a new level as we will explore now.

Speculation vs. income-generating – the role of the crypto markets

Whenever I get asked by people about my take on the whole crypto market, I give the same answer.

As a relatively conservative person, when it comes to financial markets and risk, I do not advise (short term) speculation into the crypto markets. If you have some spare money that you can afford to lose without regrets or having to change your lifestyle, the crypto markets could be worth a shot. However, you need to understand the risks that come with it and you have to understand that you could lose all your money. Make sure to really read the fine print and consult your financial advisor first.

You must understand the risks and you must understand how cryptocurrencies and the technology behind it. The amount of people who have no idea how financial markets work, what an exchange is, how blockchain works and what wallets are, but are still eager to buy cryptocurrencies is astonishing. Granted, you might not need to know all the technicals, but if you invest your hard earned money, you better do your homework.

In this context, I have to also emphasize the importance of knowing in what you invest. Many people will randomly look for the smaller cryptocurrencies just because they hope that they will hit a home run and 100x their money by next week.

If you follow such an approach, it is essential that you research in what you invest. Understanding the technology, the coin, the team and the legalities. This is especially true when investing in smaller ICOs where many horror stories are circulating through the internet. If you do not have a complete understanding of what you invest in and if you haven’t researched it, you are getting ready for a disaster.

What does it say about yourself?

I think there are many lessons that the current crypto market can teach you about yourself.

Are you the kind of guy who doesn’t do research and just buys a random crypto because of the name or because of a random tip? What does this really say about yourself, your work ethic and your attitude towards money?

Are you looking through forums or social media channels and hope to get fed a signal although you have no idea what you are actually investing in? What does it say about your greed level and your willingness to put in actual work to get to where you want to be?

Really let this sink in and learn about yourself. It’ll be a valuable lesson.

Long vs short-term

Furthermore, the time horizon of your investment decision has to be clear in advance. Do you believe in the general idea behind cryptocurrencies and the blockchain technology? Do you think that it will transform the world as we know it? Then you should probably have a long-term view and not worry about the short-term fluctuations. You are also more likely to do the research, be open to new ideas and not just hope to make a million dollars by next week.

Many people say that they want to invest long-term but immediately get into the day trading mindset where they following their portfolio tick by tick.

Forex vs Crypto

For me personally, I clearly differentiate between Forex/Futures and the crypto market. Whereas I see the crypto investment purely as a speculative, all or nothing scenario, my Forex/Futures trading has a very different role. As I stated earlier, I am keeping an eye on the development of the crypto and the blockchain scene, but from a trading perspective, other established markets such as stocks, Forex or Futures can offer a more reliable trading experience.

Reference:

(1)  Kumar: Who Gambles In The Stock Market? – Accessed through: econ.yale.edu