How technical traders apply their expertise to the crypto market

Technical analysis has become the go-to strategy for many traders to build strategies and evaluate market strategies. This is a broad topic, but essentially technical analysis relies on the use of charting tools and indicators to measure market momentum and trends. This information can be used to identify buy and sell signals and provide early insight into when market sentiment begins to change.

However, technical analysis is not without its critics, especially when it comes to cryptocurrencies. Indicators can be wrong or give contradictory signals. Additionally, cryptocurrencies have relatively short lives, especially beyond Bitcoin and Ethereum, offering little historical data to test strategies and assumptions. Additionally, concerns around wash trading and market manipulation, which we know are unique to cryptocurrencies, can be an issue.

One of the industry leaders in providing specialized technical analysis for cryptocurrencies is Katie Stockton, founder and managing partner of Fairlead Strategies, LLC, an independent research firm and investment advisor. I spoke to her about how she approaches these challenges and what she learned from covering cryptocurrencies.

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Forbes: What does technical analysis actually mean?

Stockton: I hate to say it, but I think it's a misunderstanding to call it technical analysis because it's about technology, so I wish it wouldn't be called technical analysis. It is more accurate to create a graph to explain our activities. We consider technical analysis to be one of several disciplines that can be used to understand markets, primarily to understand price trends and the possibility that inflection points may exist. It's about understanding where there are and potential areas of buying and selling pressure.

We do this by understanding supply and demand. To understand supply and demand, simply analyze prices. The only other data point where the market has a technical advantage is volume, but we focus on price. We use a number of technical indicators to remove some of the gray areas in the market and also to provide binary buy or sell signals. Takeout is usually black and white, so that's welcome.

Forbes: What are some of those metrics?

Stockton: I'll give you something like the big picture and how I think about technical indicators. I categorize them in three ways: trend following, overbought/oversold conditions, and relative strength. There are probably two or three in each category. I always tell people that you don't want too many metrics trying to get the same answer. If you do that, you'll find confirmation bias and duplication in what you're doing. And remember, this is all based on price. Therefore, it is also undesirable to take too many derivatives from the price. One of the indicators I use for trend following is the MACD, which stands for Moving Average Convergence Divergence.

What this means is that we want to buy things that are upward-sloping. Very simply, we want to buy things that go up in price, and trends have inherent momentum. Suffice it to say, when something has momentum, you should assume that momentum will continue. And that's the momentum inherent in the trend. So you really genuinely want to buy things that are trending up and sell things that are trending down or trending down. That's trend following. There are indicators to understand whether these trends remain strong. Indicators also tend to be based on moving averages of prices, such as MACD moving average convergence, divergence, and moving averages essentially look back using past prices. What we have found is that some of the metrics derived from them are very useful in identifying important changes and trends. And not only do you want to buy a rising security, you want to know when to sell it. Indicators help you know when trends change.

Below is an example of usage Bitcoin (Bitcoin) On the monthly chart. According to the monthly MACD indicator, Bitcoin has lost its long-term upward momentum, with a “sell” signal occurring in January. Although this indicator has an inherent lag, it is designed to identify large changes in trend. The last “buy” signal occurred in July 2020, followed by a strong rally.

Forbes: What are the other buckets?

Stockton: For the overbought/oversold part, we tend to gravitate toward stochastic oscillators. The objective here is to find out where the security is closing compared to the high/low range and see how the stock price has moved over that period. If the price continues to close near the top of the range, it is considered to be even more overbought. Let's talk about overused words. The same goes for the word oversold. I think overbought and oversold are mostly wrong, and overbought isn't necessarily a bad thing. When something is overbought, it reflects momentum. And then there is the actual overbought measurement, which is based on a stochastic oscillator. And it's an oscillator between zero and 100%. Anything above 80% is overbought, but I don't care about that. In fact, we like to see something more than 80% overbought. What you don't want to see in terms of following a trend or an uptrend is for it to reverse and go down. That is, when the overbought indicator drops or turns lower, that is, when we feel that there is some kind of sell signal.

We utilize this stochastic oscillator to help us understand when overbought readings ultimately impact price (and vice versa). It also helps identify appropriate entry points into stocks and securities that have been trending down. Of course, a lot of people are looking at whether Bitcoin or high-growth stocks will somehow turn around, just as an example. In that case, they want to know if this downtrend that we've been seeing is at a point where it's oversold to the point where it's turning a corner. Using this stochastic oscillator, we can get to that answer in a way that is not our opinion. It just reflects what this mathematical gauge is telling us.

Below is an example of a stochastic oscillator using Ether (ETH). Ether made lower highs in conjunction with the weekly stochastic oscillator decline from overbought territory of over 80%. Since this pertains to weekly bar graphs, it tends to last several weeks. Ethereum was also oversold in March when risk assets bottomed out, but that rally was short-lived. We see the rise and fall of the stochastic as a catalyst.

Forbes: What if you receive mixed signals?

Stockton: There is a certain degree of subjectivity involved depending on the market situation, such as whether it is a trending market or a sideways market. Trending markets require more emphasis on momentum gauges, trend-following gauges, and moving average-based gauges. In a range-limited environment, oscillatory measures such as market breadth measures and stochastic oscillators become a little more valuable.

Forbes: Cryptocurrency markets can become fragmented. How can I find out the exact price?

Stockton: That's a good question. I always like to review things that most people are paying attention to, such as mainstream exchanges. And to be honest, the first thing you usually see when you enter a ticker is the major exchange where this product is traded. We primarily use Coinbase for Bitcoin and Ether.

Forbes: Blockchain transparency has led to an explosion of technical indicators available to traders. Do you use something or are you just concerned about price?

Stockton: We only focus on price. And that's true for all asset classes, not just cryptocurrencies. We are interested in these new trends. Because these trends can also help you make informed decisions. So that's not to say we don't agree with using that as input. That's not really our expertise. One of the reasons the stock market is great for us is because there is so much data in the stock market. In addition to price data, you can also get so-called inside market information. Market participation/sentiment can be measured as a poll of investors, such as how they feel, or as a trading measure of where people stand, such as using a volatility index or put-call ratio. You can also measure it. Therefore, we have such rich data about the market internals of the stock market. One of the reasons is simply that the stock market has been around for a long time. We don't yet have the same level of price history for cryptocurrencies, but we also don't have all the data points that could be considered internal to the market. That would really help.

Forbes: I think you've seen some of the criticisms of technical analysis when it comes to cryptocurrencies, such as the challenges posed by such shallow data pools. How do you adapt to this?

Stockton: The good news about the short history of something like Bitcoin is that some degree of circularity actually already exists within that context. I call this time compression. Work that previously took six months now takes two months, and work that took two months now takes him two weeks. I think the more price history you have, the better. However, as long as you capture different types of environments, you can build models based on them. And you can trust the indicator as long as there are enough signals to analyze it. At least the technical indicators we use should theoretically carry over to something with price and liquidity. So, there will definitely be nuances, and certain time periods may be just a little more important for one security than the next, but overall I find the methodology transition to be fairly seamless. Of course, Bitcoin and Ether in particular are clearly similar to the deep liquid market. . Other things should still carry over evenly, unless liquidity is very thin and there are a lot of gaps in the chart. Not only does the gap increase depending on the news, which is normal sometimes, but the overall trend gap is: good.

FORBES: You know about wash trading and other ways that people try to manipulate the market. In particular, for assets that may be less well-known and less reliable, which are not necessarily based in the United States or are traded primarily on exchanges that do not have strong regulatory accreditation. How are you trying to explain it?

Stockton: If you're seeing something you can't trust, that's a cause for concern. Therefore, you will want to avoid it at all costs if possible. A price is a price. If there is enough volume to move the price, we will take that into account. And like I said, we don't really care about volume that much anyway.

Forbes: It's impossible for someone to be 100% right. But I'm interested in what your success rate is or if you feel that your predictions in cryptocurrencies are more or less accurate than in traditional markets.

Stockton: As such, I have no way of measuring my hit rate, as I most recently worked as a publication research analyst and money manager. You know, as money managers, we now have a way to keep track of records. The firm recently launched the Fairlead Tactical Sector ETF (TACK), which tracks technology trends across asset classes. But what you want is for people to subscribe to your research and, if you're right, follow your call often.

We may be wrong sometimes, but we'd like to think we won't be wrong for long because the metrics won't allow it. Indicators keep you honest. We don't aim to be extremely predictive, but rather to keep people on the right side of the trend, give them some risk indicators and some goals to monitor, and maybe even change their current behavior. Based on this, we talk about catalysts, etc. It's not that I think the price of Bitcoin will be X by the end of the year. We don't add value or have a crystal ball in that way. But if people can follow that opinion in a consistent way, that's where the real benefits come from.

Disclosure: I own several cryptocurrencies mentioned in this article, including Bitcoin and Ether.