A beginner’s guide to crypto market analysis
There are a wide variety of investment and trading strategies that you can employ when it comes to cryptocurrency, from HODLing to day trading. If your goal is to make a profit, though, only one thing really matters – buy low and sell high.
This is, of course, easier said than done. If it wasn’t, we’d all be rich. Identifying when the lows and highs will come is exceptionally hard and doing so with any degree of certainty is impossible – no-one can truly predict the future.
But there are certain methods of market analysis that crypto traders and investors commonly use in their decision-making processes to give them a better idea of when to enter and exit their positions (in other words, to buy and sell). The two most common of these are technical analysis and fundamental analysis. Both have their limitations, but used in the right way, they can help you make better informed trades.
The legal stuff: The content of this article is for information purposes only and is not investment advice or any form of recommendation or invitation. Luno always advises you to obtain your own independent financial advice before investing or trading in cryptocurrency.
What is it?
Technical analysis is built on the premise that history repeats itself. It’s focused primarily on historical market data, such as trading volume and past pricing trends, rather than what a coin or project actually does. Analysis of this data is used to build a clearer picture of market sentiment by identifying patterns of repeat behaviours. This can then help you to make calculated predictions about when the market will be bearish (trending down) or bullish (trending up). These predictions should, in theory, allow you to buy when the market price is low and sell when it’s high in order to make a profit.
This method of analysis essentially assumes that price movements aren’t random and that past patterns will hold in the future. Although any number of factors could have influenced the price of a coin to move in a specific direction, in technical analysis you really look only at supply and demand and the price of a coin. After a trend is formed by a coin, technical analysis’s exponents believe that it’s probably going to follow that trend to oppose it. So, if the market is bullish for a substantial amount of time, demand will reduce the supply of coins for sale and the price will increase. As the price goes up, you can expect it to become bearish at some point as people try to capitalise by selling their coins. As they sell, supply begins to outweigh demand, causing the price to go down. And the cycle continues.
Does it work?
Ultimately, technical analysis is such a broad discipline that it can’t be said to simply “work” or “not work.” Its success depends largely on the person doing the analysis. This isn’t to say that it necessarily has to be complicated and you have to be a mathematical genius, but it is easy to misinterpret and you have to know what you’re doing.
If used correctly, TA can certainly form a pillar of your thought process and there are some that swear by it. Equally, you can’t predict the future simply by looking at the past. There are many factors to take into account. Expert technical analysts rarely rely on it in isolation, they’ll also look for context.
What is it?
Fundamental analysis is a more ‘big picture’ approach than technical analysis. It strives for a thorough evaluation of an asset’s intrinsic value, considering as many qualitative and quantitative factors as possible. If you judge the intrinsic value to be lower than its current market price, you can trade accordingly and, in theory, make a profit. Equally, if you believe the asset to be overvalued, you can actually trade to make a profit when assets decrease in price. This is known as ‘shorting’.
Fundamental analysis is not exclusive to cryptocurrency. It’s common to all kinds of trading. However, it does require a different approach. Cryptocurrencies are not corporations. They do not have public financial statements. This makes it hard for traders to derive a precise valuation for Bitcoin from future cash flows in the way you can for other assets.
A cryptocurrency’s viability depends on other factors to gauge its potential and the current strength of the community in the network. There are future prospects and unique features to consider. With Bitcoin, you would ask whether it will function as a medium of exchange and what sets it apart from money. For example, Bitcoin’s total supply is fixed at 21 million units. It’s therefore in a unique category of its own among currencies. Unlike fiat currency, which a central bank can print at will, Bitcoin possesses a fixed and predictable total supply volume.
You also look at things such as transaction volume and user activity to gauge consumer demand, as well as retail adoption. Bitcoin has made slow but steady progress toward mass adoption as a medium of exchange. Today, it has been adopted as a payment method by tens of thousands of businesses and e-commerce platforms worldwide. In fundamental analysis, this might help you understand whether it is performing its intended function as you saw it.
Finally, global economic events can exert a powerful influence on cryptocurrency prices. It’s important to incorporate these economic shifts when using fundamental analysis in a trading strategy. This includes both scheduled and unscheduled events. A highly-publicised and important crypto-related event such as the halving, for example, has a clear impact on the future supply rate of the currency. You can plan for this and incorporate it into your models. Equally, an unscheduled event could have an even greater impact – for example, a government’s decision to deregulate Bitcoin. This is obviously harder to take into account, but you still need to know how to respond to such unplanned events if and when they occur.
Does it work?
There are some that argue the prices of digital assets already incorporate all of the disparate data points that could possibly affect their price. This essentially renders any further attempt to assess the market redundant. Furthermore, as with any asset, it’s impossible to accurately predict demand and there will always be an element of chance. Fundamental analysis is primarily concerned with a digital asset’s hypothetical worth, rather than its actual value at any given point in time.
However, knowledge is power. By leveraging the insights delivered by fundamental analysis, Bitcoin traders and investors can gain a deeper understanding of the intrinsic price of the currency. This could ultimately assist them in making more informed and profitable trading decisions.
Which is right for me?
Technical analysis is designed more for short-term trading. This is because the course corrections it looks for can happen within days, if not hours. However, it is also used for guidance on general long-term upward and downward trends.
The main mistake that you could make when they are starting out is relying too heavily on technical methods. Even TA’s biggest fans acknowledge that it’s unlikely that you will be successful using it in isolation. You need other information and context. Equally, fundamental analysis isn’t perfect either and will often reflect what a security should be worth, as opposed to what what its actual market price is.
Most traders aim for a contextualised and balanced use of fundamental analysis and technical analysis, in a nuanced analytical process which also takes into account fundamentals, as well as other information such as order flow info and Smart Money participation. Ultimately, it’s down to you to figure out what this looks like. This process will be dictated by your personal circumstances and will often be trial and error. If you do decide to take up trading, make sure to be cautious during this phase and never invest more money than you can afford to lose. One fact remains true for any trading strategy: the usefulness a method of analysis has depends on how you use it. Do your own research and rely on information from trustworthy sources. In the world of digital currency, knowledge is power, so the more you know, the more successful you will be.