Introduction – Cryptocurrency Markets
Cryptocurrency markets have exploded in popularity in 2017.
01-Jan-2017, the total cryptocurrency market capitalization was $17.6B and as of 02-Sep-17, this figure was hovering at $170B before sharply correcting back to $140B as of 10-Sep-17. Over a 10x increase for the ENTIRE market, followed by a 18% correction for the ENTIRE market.
Although the recent increase of the cryptocurrencies’ market cap has been substantial, the market cap is still quite low compared to those of Forex or Equities. In fact, the entire cryptocurrency market cap is still less than the $180B market cap of Phillip Morris (PM), who manufactures and distributes tobacco and other nicotine-containing products... That puts things in perspective.
This increase in market cap has been joined by increases in daily crypto trading volume, which has exploded from $130M to upwards of $9B, a 69x increase. Yes, this increase absolutely seems frothy. However, I believe that that this growth will not only continue, but will increase. Cryptocurrencies are here and they are volatile. What started with Bitcoin, the Cryptocurrency market has evolved and recently started to gain critical mass with investors, traders, entrepreneurs and consumers.
These markets are young, volatile, borderless, and available 24/7 - and are a playground of inefficiencies. Crypto markets are still in their infancy and we are only starting to see an influx of institutional interest. This means that there are significant excess returns to be had for the opportunistic trader - especially when compared with other more traditional markets.
With this surge of new interest come new market participants. More and more traders are looking for a way to maximize their trading earnings. When scouring the internet for ways to successfully trade these markets, one inevitably encounters the two primary methods used to try to predict an asset’s future price, Fundamental Analysis and Technical Analysis.
Fundamental Analysis (FA)
Fundamental analysis is the evaluation of economic, financial and other key intrinsic properties, known as “fundamentals”, to determine an asset’s true value. In traditional markets, this would involve determining an asset’s price using Revenue, Dividends, Profits, and/or Cash Flows. In younger markets, such as Crypto, most traditional FA valuation models are difficult to apply to cryptocurrencies as they will have little or no cash flow, and difficult comps.
Crypto FA takes on a broader form of prediction and should be used to provide a framework or basis of value. For example, Does X blockchain have competitive or technological superiority to Y blockchain?
Fundamental analysis will also investigate qualitative factors about the cryptocurrency such as transaction activity, supply amount, inflation rate, development team, technology’s use-cases, and other relevant news to determine if a cryptocurrency’s use is likely to increase and move toward more mass adoption. Crypto FA will also take into consideration major events. These incidents are sometimes directly related to bitcoin, such as the hack of a major exchange, or a setback in the community's push to solve the scaling dilemma.
FA is typically used to make longer-term investment decisions and critics often argue that market prices and FA valuations often vary drastically and remain at odds for extended periods of time.
Technical Analysis (TA)
Technical Analysis is the use of past price movements to forecast future price movements in an asset. TA involves reading indicators and chart patterns to attempt to determine price trends, which occur as a result of changes in supply and demand of an asset, creating repeated somewhat predictable patterns.
Day traders typically use technical analysis almost exclusively and looks at past price action, patterns, and momentum indicators to determine future values, being less/not concerned with the asset’s fundamentals. TA is typically used for shorter term trades, but can be used to help make longer term trading decisions (entry/exit price).
A Note on Strategy
There are many different Technical analysis indicators: Moving Averages, Moving average convergence divergence (MACD), Relative Strength Index (RSI), Commodity Channel Index (CCI), etc. – everyone has their favorites and each indicator will do its job in terms of calculations. All of these indicators are taking price and volume data and using this to attempt to predict future price movements. However, there is absolutely no "holy grail" single indicator or signal. Profiting using TA in trading is less about how individual trading indicators work, and rather more about how these indicators are used as part of a trading plan.
In traditional markets I am a firm believer in an analysis more concentrated on FA. I believe an integral part of fundamental analysis in today’s markets is determining sentiment through big data. Gleaning trends and sentiment from the many social channels used in society gives valuable insight into potential money flows.
My recommendation is to blend technical analysis and fundamental analysis to make sensible trading decisions. Positive fundamentals and the use of technical analysis to determine a good entry point will typically give you the best chance of increasing your trading profits.
Please stay tuned for Crypto Markets - Improving Trading Beyond Technical Analysis (Part II), where I'll go in to a bit more detail on Technical Analysis.