UK Edition
Anyone roaming into the world of cryptocurrency for the first time would do well to take any advice, tips or guidance with a healthy pinch of salt.
It is easy to be put off. Any investment that inspires such fervent evangelicalism should trigger red flags. Crypto investors can be blindingly confident to the point of aggression, and so firmly set against traditional finance that many do not bother to pay attention to tried-and-tested investment strategies.
Yet ignoring cryptocurrencies, particularly in the past five years, has potentially cost those who have not taken the asset seriously. Bitcoin, the most mainstream crypto, has surged by more than 1,000pc in US dollar terms since 2018.
Its proponents argue that Bitcoin can act as a safe haven during periods of recession, inflation and economic uncertainty. This is because like physical gold it is scarce – only 21 million Bitcoins can ever be created, which means that its value could rise when normal currencies lose their buying power.
Another key argument is that Bitcoin and other cryptocurrencies can serve as a hedge against currency debasement: this is the idea that fiat currencies will lose their value because of monetary inflation and the expansion of central bank balance sheets.
To outsiders, cryptocurrency prices seemingly track market sentiment over all else – but traders believe that like traditional markets, these assets also go through their own price cycles.
Below is a breakdown of some of the basic indicators that Bitcoin traders follow – but it is important to note that while many DIY investors have made chunky profits by investing in cryptocurrencies, experts typically recommend that investors seeking a balanced portfolio should not allocate more than 5pc of their money to the asset.
The Financial Conduct Authority, the City regulator, has previously warned that people buying Bitcoin did not understand it and it was extremely risky as prices could fall to zero. Cryptocurrencies are not protected by the Financial Ombudsman Service or the Financial Services Compensation Scheme.
The Bitcoin ‘cycle’
While like any asset, cryptocurrencies can also be affected by the macroeconomic environment, some crypto traders believe that Bitcoin’s price has developed a cycle.
The theory goes that when Bitcoin peaks at a new all-time high, it then suffers a painful drop of around 80pc, usually bottoming after a year.
The price then starts to recover and takes about two years to reach a new all-time high. It can then rally for a further year until the cycle repeats.
For example, the Bitcoin cycle below shows that Bitcoin hit a peak in late 2017. It then bottomed around a year later, and rallied until late 2021, boosted by a rush of easy money during the pandemic.
Some traders also follow Bitcoin “halving” cycles. This is when the reward for mining new blocks is halved, which means that miners receive 50pc fewer bitcoins for verifying transactions.
Bitcoin halvings typically occur once every 210,000 blocks, or around four years, until the maximum 21 million Bitcoins has been generated by the network.
This timeline is crucial for market watchers to follow because they radically reduce the number of new Bitcoins that can be generated. The limit of supply on new coins theoretically drives up the price.
The next halving event is expected to occur in April 2024, when the number of blocks will hit 740,000. The block reward will fall from 6.25 Bitcoins to 3.125 Bitcoins. Traders have speculated that Bitcoin bottoms around a year ahead of halving.
Moving Averages
A key way that cryptocurrency traders follow the “direction of travel” of prices is through measuring moving averages. In short, this is the theory that a price is more likely to continue moving in the direction of a trend that has already been established.
A moving average shows the average price of a specified number of recent “candlesticks”. These are chart visualisations which represent four price points: open, close, high and low.
If a cryptocurrency is moving above its 50-day moving average, it suggests there is upward momentum.
On a price chart, the moving average is represented alongside the price as a line that changes over time.
When the price approaches the moving average, it can either suggest the price will continue upwards or points to further decline, depending on the direction of the movement.
Simple Moving Average
This calculates the average price over a specific time period.
- Simple Moving Average = (A1 + A2 + … +An)/ n
- Where An= the price of an asset at period n
- n=the number of total periods
Weighted Moving Average
This is designed to focus on recent data rather than past data. Traders multiply each bar’s price with a specific weighting factor. This is often closer to prices than a simple moving average.
- Weighted moving average= Price1 multiplied by n + Price2 multiplied by (n-1)+/ ((n multiplied by (n+1)/2)
- where n=time period e.g. days
- A weighted moving average is more sensitive to price fluctuations.
Exponential Moving Average
This is a similar but more complex indicator, which places greater emphasis on the latest data.
- Current EMA = (Current value multiplied by (Smoothing/1+n)) + EMA yesterday multiplied by (1−(Smoothing/1+n)
- n= time period e.g. days
- The smoothing factor can change, but the most common choice is 2
Relative Strength Index
This is a momentum indicator that uses the speed and direction of price movements to determine how much further it could go.
Simon Peters, of eToro, said: “The RSI ranges from 0 to 100. Typically an RSI above 70 denotes the overbought zone and an RSI below 30 denotes the oversold zone.
“It’s not a formality that the price action will reverse if the RSI goes into overbought or oversold zones. So as well as looking for RSI to be overbought or oversold, traders will also usually look for RSI ‘divergence’ with the price action.
“For example if the price was in a downtrend making ‘lower lows’, but the RSI indicator is making ‘higher highs’ this could signal that momentum to the upside is increasing and the price action could begin trending upwards in the next cycle,” he said.
“See the divergence between the two blue lines on the price chart and the RSI indicator at the bottom. This could have given a clue that an upwards move in price action was to happen.”
Fibonacci Retracement
In mathematics, a Fibonacci sequence is a pattern in which each number is the sum of the two preceding ones.
In the world of cryptocurrency, traders use this sequence to show how much of a prior move a crypto price has retraced.
For example, a trader follows Fibonacci ratios of 23.6pc, 38.2pc, 61.8pc and 78.6pc.
A trader can use the Fibonacci retracement tool by connecting the low point and high point of a recent price movement on a chart. This can help them determine where a price retracement will end and the start of a new cycle in the direction of the main trend will begin.
Mr Peters said: “See this recent upwards move on Bitcoin. Connecting the low to the high using the Fibonacci retracement tool auto populates the levels.”
However, Mr Peters added that no trader or investor should rely solely on this indicator. “There is no guarantee the price will reverse after reaching or touching one of these levels.
“Instead traders and investors should build a bigger technical picture using other indicators – such as RSI for example. The more indicators in agreement generally the greater the probability of being successful.”