Technical analysis and Bitcoin

Many traders ask themselves what is the best way to exploit technical analysis to trade bitcoin succesfully. This is not an easy question to answer. Technical analysis is a tool which can be surely used also with cryptocurrencies. The trouble is that the crypto market is more complex than the simple forex market and makes it difficult for the noncomputer literate to trade. The combination of the technical analysis complexity and the cryptomarket complexity makes the system very difficult to manage, at least for the beginners.

These limitations makes cryptos difficult to trade, and this is why this asset class is often traded by more risk adverse and technologically inclined investors. The consequence is that the market remains small. The low market liquidity is another big problem, because it creates several ups and downs and can create false signals. Despite all these difficulties, the researcher Philip Daniel, in his paper ‘Technical Analysis in the Virtual World’ discovered that technical analysis can indeed give traders satisfaction, with many technical indicators he tested which have different strengths and weaknesses.

Ultimately, he wrote in his conclusions, “we see that technical analysis is very effective when applied correctly. More abstractly we must ask why do these tools work so well. In my opinion it boils down to the availability of this information. Due to the computer savvy culture surrounding bitcoin, data is free and easily accessible. Websites such as allow the creation of charts with numerous technical indicators without the knowledge of more formal and expensive charting software. With the information being easily accessible to everyone, the theories of technical analysis being easily obtainable online, we observe a situation of self fulfilling prophecies.”

Philip Daniel, in his paper ‘Technical Analysis in the Virtual World’, tried to discover how a typical trader approaches short term trading in the bitcoin market. ‘Traders can follow the indicators and sell and buy accordingly, essentially proving the indicators correct, especially in the short term. Understanding how traders believe in technical analysis can allow us to capitalize on the indicators movements. The key is to think ahead of the average trader’, he concluded.

In order to demonstrate this, he used the RSI indictor as an example. ‘By examining the angles or slope of these indicators, while keeping in mind fundamentals, we may have a better shot at beating the market. Another approach could be to narrow our trading range, especially in the case of the RSI index. The RSI index being one of the most self fulfilling indicators with clear boundaries of when you “should” buy and sell. This being common knowledge, the market follows this index very well, especially in the short term. The risk lies in missing the peak. A viable strategy would be to buy when RSI traditionally says oversold and sell shy of the overbought line. Traders will typically wait for that clear signal of RSI>70 to sell, but if we sell at a lower RSI, say greater than 65, this is safer and depending on the size of the investment may decide the short term peak. This approach will lower our risk when using the RSI index at the cost of potential profits. Ultimately it depends on the investors risk tolerance.’

The future of bitcoin is difficult to predict. Steeped in technological barriers and a history of fraud, some believe bitcoin may have crashed beyond recovery.

On this topic, Daniel believes that the overall bitcoin trend may be following Gartner’s Hype Cycle. Bitcoin has already reached the “Peak of Inflated Expectations” and has been headed down. If it here to stay, it is possible that we are in the “Trough of Disillusionment”, and will soon be entering the “Slope of Enlightenment”. This all depends on whether or not the bitcoin community can overcome the apparent complexity and issues of trust. Only time will tell. Bitcoin is only the first of its kind. If it ultimately fails it will not be long before someone creates something similar. As wealth becomes more and more virtualized we will see more and more markets like the bitcoin market are created where this type of analysis proves to be very lucrative. Ultimately, the key is information, not just technical, but knowing about the market first. Internet markets are easily created and easily destroyed. By being a creator, or early participant armed with an understanding of the successful indicators, the potential returns are incredible.”

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