Technical analysis and cryptocurrencies Does it make sense

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Does it make sense to combine technical and fundamental analysis?

patrick.b

Newbie

glad to be part of this forum. Hope to contribute myself as time goes on.

I have traded in and out for some years but only recently touched the sides on ‘investing’. I used to trade fx on and off but never had any luck with technical analysis. I always found that I’d be getting into low profitable setups through support and resistance and other means never really excelled in this manner.

In recent times I tried my hands with a different approach. I bought a CFD in Ethereum a while back and made some money through a fundamental approach, seeing what other people are saying about the asset, researching things myself etc; and for me this seemed like a transparent way of doing things. In recent times I have also bought Apple CFD along the same mental view, using my own knowledge of the brand and experience with the brand etc; (I use Apple so I feel like I know the brand well from a consumer point of view).

My way of investing or trading in both of these assets hasn’t been from reading annual reports or price to earnings ratios but to use my own research of the product itself and my knowledge of the brand from a consumer point of view. I feel like I’m not the only person who has taken this approach. ‘Invest in what you know’.

Now, the question here is that does it make sense to combine technical analysis along with fundamental analysis? So when I bought Ether or Apple I’d always buy on a dip or maybe an area of support etc; which of course is a technical viewpoint, however I wouldn’t make my buying decision based on this, it would be based on my own views from news on the web etc; however using these technical entry points seems logical.

I’m just wondering whether this makes sense to combine the two like this and whether you do yourself.

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Cryptocurrencies don’t make sense

Jon Danielsson 13 February 2020

Cryptocurrencies are supposedly a new and superior form of money and investments – the way of the future. The author of this column, however, does not see the point of cryptocurrencies, finding them no better than existing fiat money or good investments.

I have been trying to understand what the point of cryptocurrencies is, without success. They may not be an immediate financial stability concern (den Haan et al. 2020), but I just don’t get them.

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As far as I can tell, they are supposed to be some combination of:

  • a type of money;
  • an investment;
  • something that provides privacy and security and efficiency;
  • something else, new and magical and mystical that I am too stupid or old to understand.

Are cryptocurrencies money?

What do we need money for? Three things:

  • facilitating transactions;
  • a store of value;
  • lending of last resort.

Any form of money should be evaluated according to those criteria.

We have used many things throughout history as money, like seashells, cigarettes, silver and gold. These are all scarce real assets with value to their users, available in small units and easy to transact.

No country has such money anymore. Instead, what we use is fiat money, a currency without any intrinsic value. Paper printed by the government, whose quantity is amplified by the financial system. It is only valuable because the government guarantees it is.

Fiat money issued by a credible modern central bank is vastly superior to money based on real assets like gold, not least because the supply of fiat money can be adjusted to best serve the economy, rather than be dominated by the production of some natural resource. The volume of cryptocurrency cannot be adjusted in the same way.

Of course, governments are tempted to abuse fiat money and print too much, as the first creator of fiat money did, the Chinese government in the 13th century. More recently, the stagflation of the 1970s is due to the central banks being bad stewards of money.

Because the governments of the time could not be trusted, several thinkers proposed free monetary systems, such as Hayek in 1977, discussion which presages current cryptocurrency debates. Still, advances in monetary policy eventually gave us more stable money by the 1980s.

So how do cryptocurrencies stack up on the criteria for money mentioned above: as a store of value, ease of transactions and for lending of last resort?

They are vastly inferior for transactions. Transactions with cash are costless, anonymous, and immediate. Electronic transactions are very cheap and also immediate, and can be done in any amount.

Bitcoin transactions take an hour or more, with a cost of at least $25, and they are not all that anonymous. Yes, there are cryptocurrencies that promise more efficiency or privacy. But even then, while it can take a long time to find someone who accepts Bitcoin, it is much longer with the competitors. Meanwhile, the largest amounts that can be transacted by cryptocurrencies are dwarfed by those one can transact with fiat money.

And what about store of value? Neither cryptocurrencies nor fiat money have any intrinsic value. What matters is credibility – our expectation that the money will retain its value over time.

For fiat money, the central banks are committed to keeping its value stable at a decreasing rate of 2% per year. The major central banks have been quite successful at keeping their tracking error small for a long time.

Bitcoin and other cryptocurrencies are much inferior in this regard. Their value doubles or halves in a span of few days. One cannot say with any degree of certainty that one’s holdings of cryptocurrencies will hold their value over the next week, not to mention a month or year. If one holds cryptocurrencies, it is for speculative reasons, not as a store of value.

That leaves lending of last resort (LOLR), providing liquidity to financial institutions in times of crises. This has been an essential function of central banks ever since Walter Bagehot’s 1873 analysis of the 1866 crisis. LOLR was last used in 2008, and will certainly be needed again at some point in the future. There is no such facility in any of the cryptocurrencies.

If cryptocurrencies are money, they are a much inferior money to existing fiat money.

Are cryptocurrencies investment?

Cryptocurrencies, along with fiat money, have been called Ponzi schemes. Not quite. The definition of a Ponzi scheme is an investment where existing investors are paid for by new investments. Neither cryptocurrencies nor fiat money fit the definition.

But are the cryptocurrencies an investment? It depends on what one means by investment.

The value of a stock or a bond reflects future income appropriately discounted to the present. Not so with cryptocurrencies or fiat money. They have no intrinsic value. Their value is caused by scarcity, as well as the cost of mining or government promises. However, mining is sunk cost, not a promise of future income.

The only reason cryptocurrencies retain value is because we expect other people in the future to value them the same, or more than we do now. Just like collecting stamps. The value of stamps is created by scarcity and expectations of future investors pricing them more highly than we do now.

Cryptocurrencies are not an investment in the same way as a stock or a bond. They are an investment in the same sense as stamp collections are.

However, even then, most people don’t use fiat money directly as a store of value except in small amounts. At the very least, one can keep fiat money in a bank account or government bonds that earn interest. An investment that is as safe as the government. The possibility of such near riskless lending at stable rates is absent for cryptocurrencies.

So if cryptocurrencies are an investment, they are more like stamps or lottery tickets than fiat money, stocks, or bonds.

Credibility

The intrinsic value of fiat money is underpinned by the credibility of the government and the central banks tasked with controlling money.

Central banks are independent and with considerable political cover, essential to ensure the credibility of fiat money. Countries that disregard the latest developments in monetary policy, like Venezuela, do that to their cost.

Central bank independence, political cover, and reputation for competence are key. Jerome Powell, the current chair of the Federal Reserve system, is the most powerful bureaucrat in the world. General Joseph Dunford, Chairman of the Joint Chiefs of Staff, might have nuclear weapons in his arsenal, but he reports to President Trump. Jerome Powell does not.

While our faith in central banks has increased considerably since Friedrich Hayek wrote his article cited above, it could still be higher. However, I can download detailed performance statistics on fiat money dating back decades. I know the supply of money and I know the policy tools used and I can make up my own mind. Information about cryptocurrencies and other activity statistics is much harder to come by and they have a much smaller history.

The value of the euro and of the dollar is underpinned by the credibility of the ECB or the Fed. With cryptocurrencies, it is the credibility of some unknown entities and processes.

I trust the central banks in developed economies much more than I trust any of the cryptocurrencies.

Privacy and security

That leaves privacy and security.

Cash is 100% anonymous, but one is at some risk of theft. Electronic transactions are not anonymous, but are safer.

While some cryptocurrencies promise anonymity, the most popular, Bitcoin does not, unless one is really careful in hiding one’s tracks using skills that are only available to a small group of users. The reason is that transaction records on the blockchain cannot be changed or deleted and are therefore searchable.

Meanwhile, not a day passes without reports of theft from cryptocurrency investors. The best advice is to keep one’s private key on an air-gapped burner laptop.

Cash and electronic money are also subject to theft. Still, there is no need for a private key with cash transactions and keys are much less important for electronic cash transactions. There are multiple layers of security that protect us. The fiat money of non-expert users, provided they take basic precautions, is very safe.

I feel quite confident in doing online banking without resorting to an air-gapped burner laptop.

Cryptocurrencies are only safe from theft if one is expert and takes elaborate precautions. We are much more likely to be a victim of a crime with cryptocurrencies than cash or electronic money.

Cryptocurrencies are inferior to most fiat money and investments, while they do not provide privacy or security.

When I say this to advocates of cryptocurrencies they usually respond in two ways – that I don’t understand cryptocurrencies, and that they have new and wonderful qualities that I miss.

There are many things I don’t get, but I have put some effort into understanding the mechanics of cryptocurrencies. However, one can know all the mechanics, all the geeky technical details, and still not have a clue about what they mean.

Take as an example human beings. I can know all the physics and chemistry and physiology, understand how molecules and organs operate, yet still don’t know the first thing about an individual.

Its the same with cryptocurrencies. Knowing the mechanical details does not translate to understanding their economic function.

Cryptocurrencies are more like a religion or a cult, not a rational economic phenomena. They even have their own foundation myth, the elusive Satoshi Nakamoto.

Bitcoin and Crypto Technical Analysis For beginners

Last Updated Feb 19, 2020 @ 15:24

Crypto traders have several tools to assess the cryptocurrency market. One of them is an approach known as Technical Analysis. Using this method, traders can get a better understanding of the market sentiment and isolate significant trends in the market. This data can be used to make more educated predictions and wiser trades.

Tech analysis considers the history of a coin with price charts and trading volumes, no matter what the coin or project does. As opposed to technical analysis, fundamental analysis is more focused on establishing if a coin is over or under valued.

To get a better idea of technical analysis, it is crucial to understand the fundamental ideas of Dow Theory that tech analysis is based on:

  1. The market considers everything in its pricing. All existing, prior, and upcoming details have already been integrated into current asset prices. With regards to Bitcoin and crypto, this would be comprised of multiple variables like current, past, and future demand, and any regulations that impact the crypto market. The existing price is a response to all the current details, which includes the expectations and knowledge of each coin traded in the market. Technicians interpret what the price is suggesting about market sentiment to make calculated wise predictions about future pricing.
  2. Prices movement aren’t random. Rather, they often follow trends, which may either be long or short-term. After a trend is formed by a coin, it’s probably going to follow that trend to oppose it. Technicians try to isolate and profit from trends using technical analysis.
  3. ‘What’ is more important than ‘Why’. Technicians are more focused on the price of a coin than each variable that produces a movement in its price. Although multiple aspects could have influenced the price of a coin to move in a specific direction, Technicians assertively review supply and demand.
  4. History tends to get repeated. It is possible to predict market psychology. Traders sometimes react the same way when presented with similar stimuli.

Trend Lines

Trend lines, or the typical direction that a coin is moving towards, can be most beneficial for traders of crypto. That said, isolating these trends can be easier said than done. Crypto assets might be substantially volatile, and watching a Bitcoin or crypto price movement chart will probably reveal a selection of highs and lows that form a linear pattern. With that in mind, Technicians understand that they can overlook the volatility and find an upward trend upon seeing a series of higher highs, and vice versa – they can identify a downtrend when they see a series of lower lows.

Additionally, there are trends that move sideways, and in these cases, a coin doesn’t move significantly in either direction. Traders should be mindful that trends come in many forms, including intermediate, long and short term trend lines.

Important tip: you must be accurate when drawing these trend lines! How to do it perfectly? As you hover each candle you will notice the lowest price of it marked as “L” in the top bar (or the highest price, “H”, if line’s direction is down). Now place your line exactly there. Next, extend the line roughly, as it touches the next candle in the trend line, do the same – check exactly the “L” for that candle. Now correct your line. Final step is to auto-extend the line using line’s Settings – Line extend to the desired side (probably right). This explain was for Coinigy charts, but should work well with other chart applications.

Resistance and support levels

As there are trend lines, there are also horizontal lines that express levels of support and resistance. By identifying the values of these levels, we can draw conclusions about the current supply and demand of the coin. At a support level, there seems to be a considerable amount of traders who are willing to buy the coin (a large demand), i.e., those traders believe that the currency is priced low at this level and therefore will seek to buy it at that price. Once the coin reaches close to that level, a “floor” of buyers is created. The large demand usually stops the decline and sometimes even changes the momentum to an upward trend. A level of resistance is exactly the opposite – an area where many sellers wait patiently with their orders, forming a large supply zone. Every time the coin approaches that “ceiling”, it encounters the supply stacks and goes back.

There is often a situation in which trade-offs can be between support and resistance levels: gathering close to support lines and selling around the resistance level. This opportunity usually takes place when lateral movement is identified.

So what happens during breakout of resistance or support level? There is high probability that this is an indicator which is strengthening the existing trend. Further reinforcement of the trend is obtained when the resistance level becomes support level, and being tested from above shortly after the breakout.

Note: False breakouts occur when a breakout happens, but the trend doesn’t change. Hence, we must use some more indicators, such as trading volume, to identify the trend.

Moving averages

Another technical analysis tool for crypto currencies and technical analysis in general, in order to simplify trend recognition, is called moving averages. A moving average is based on the average price of the coin over a certain period of time. For example, a moving average of a given day will be calculated according to the price of the coin for each of the 20 trading days prior to that day. Connecting all moving averages forms a line.

It is also important to recognize the exponential moving average (EMA), a moving average that gives more weight in its calculation to the price values of the last few days than the previous days. An example is the calculation coefficient of the last five trading days of EMA 15 days will be twice that of the previous ten days.

In the following graph we can see a practical example: If a 10-day moving average crosses above a 30-day moving average it might tell us a positive trend is coming.

Trading Volume

Trading volume plays an important role in identifying trends. Significant trends are accompanied by a high trading volume, while weak trends are accompanied by a low trading volume. When a coin goes down it is advisable to check the volume which accompanied the decline. A long-term trend of healthy growth is accompanied by a high volume of increases and a low volume of declines. It is also important to see that volume is rising over time. If the volume is decreasing during increases, the upward trend is likely to come to an end, and vice versa during a down trend.

Not on the technical analysis alone

Using technical analysis, traders can identify trends and market sentiment and they also have the ability to make wiser investment decisions. However, there are a number of key points to consider:

Technical analysis is a practical method that weighs past prices of certain coins and their trading volume. When considering entering a trade, it is not recommended that you only rely on technical analysis. Especially in the field of crypto, a field that often generates news, there are fundamental factors that have a significant impact on the market (such as regulations, ETF certificates, mining hash, etc.). Technical analysis only ignores and can’t predict these factors, so the recommendation is to mix together the technical analysis and the fundamentals analysis to make wise investment decisions.

An analyst who makes a decision to buy a particular coin due to fundamental reasons can get technical support or find a good technical entry point and thus strengthen the trade’s ROI.

From Theory to Implementation: How to start and identify trends?

In order to get started, we need an analytics tool that draws graphs quickly and easily. You can use the existing graphs of the crypto exchanges, but they don’t provide trend lines and they only provide partial indicators.

TradingView: The well-known graph and charting service, with wide variety of options. Mostly free, except from premium paid features.

Coinigy provides a comprehensive charting service among all trading coins and crypto exchanges. You can register following this link and get 30 days free trial.

This guide had presented the basic concepts in technical analysis among crypto. It is recommended that you deepen your knowledge in the field if you wish to implement tech analysis: indicators, Fibonacci levels, patterns (triangles, for example), and more. In our following featured article you will read about 8 tips for trading crypto. Some touch the technical aspect.

December 2020 update: We recently published an advanced guide for crypto technical analysis.

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About The Author

Yuval Gov has over 15 years of trading experience in the stock exchange, graduated from TAU – Economics and Management. Fell in love with the crypto space. Does Crossfit to get away from FOMO. Contact Yuval: LinkedIn

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