Investing in cryptocurrency isn't easy. The assets are volatile and easily influenced. Volumes are low enough for a single large trader to move the markets significantly. The coins are so new that their long and even medium-term trends are a challenge to predict. No one knows whether the right level for Bitcoin is $7,000, $17,000 or even $170,000. Part of the fun of investing in cryptocurrencies is knowing that you're there at the start of something new.
But that also means that making money with cryptocurrencies is highly risky. Buy and hold might be a way of showing your loyalty to the blockchain but if the right level for Bitcoin actually turns out to be around $70, your membership fees to the Bitcoin club are likely to be very expensive indeed.
A better option is to let the long term trends take care of themselves while you invest in the short-term, using technical analysis to predict the immediate movements of altcoins.
It's a technique borrowed from traditional investing. Assets might trend bullish or bearish over a period of time but within that trend will be movement up and down. A stock might rise five points one day, then fall three points the next before rising a couple more points the following day. Overall, it's rising, making money for people holding the stock, but each of these intervening movements is an opportunity for making money.
Technical analysts and day traders can't predict exactly what an asset is going to do but they can look for patterns in those movements, and use them to pick the right times to buy and sell, often several times a day.
When an asset trends upwards, for example, they might notice that it never rises more than ten points at a time and never falls more than five. As an upward movement approaches ten points, they'll assume that it's approaching a peak. They'll sell, believing that they're selling at the top. As a fall approaches three points, they'll buy, believing that they're buying at a low.
In practice, the methods used by traders who employ technical analysis are much more complex. Double Top or Double Bottom patterns, for example, occur when a price reaches the same height (the resistance level) or the same depth (the support level) twice without breaking through. Investors assume that the pattern marks a change in the long-term trend.
A Head and Shoulder Top has three peaks in a row, with the middle peak the highest, and the lows between them creating a neckline. That pattern too predicts a change in the direction of a trend from bullish to bearish or vice versa.
For the most part, though, technical analysts often spend their time drawing triangles that connect peaks and troughs to reveal a general direction and predict when that direction is likely to change.
Despite its complexity, technical analysis does have some benefits for cryptocurrency traders. First, the strength of the asset itself doesn't matter. Whether it's backed by the blockchain or influenced by the decisions of central bankers is irrelevant. All assets move up and down, regardless of the technology behind them.
The volatility of digital coins isn't entirely irrelevant but it matters less to short-term traders. Technical analysts might find themselves drawing sharper triangles and looking for patterns in the sharper movements of volatile assets, but they have plenty of data points to draw on and lots of opportunities to make quick, profitable trades.
And most importantly for cryptocurrency traders, the long term trends aren't relevant either. Whatever level Bitcoin reaches before it settles down isn't important. The only thing that matters is what the candlesticks suggest will happen in the next few hours or days. As long as there's movement there's opportunity, and there's always plenty of movement in the cryptocurrency market.
There are risks though, of course. Betting on small, short-term movements brings small rewards so it's tempting to amplify them with leverage. Reddit pages are filled with stories of investors who won big on Bitcoin then lost it all when their analysis had them take a position in the wrong direction. Once their losses reach the size of their principal, they lose everything.
The multiplicity of patterns and strategies can also be confusing. Critics have described technical analysis as little more than an exercise in drawing triangles, and have argued that it's possible to make those triangles point in any direction you want. They recommend influences such as regulations, trading volume and market sentiment as more powerful indicators of future movement even if they're harder to measure and difficult to identify. Technical analysts often claim to follow a particular technical strategy. (Philakone, a professional cryptocurrency trader, describes himself as "married to Elliot Wave Theory.") But that choice ignores other strategies that might have a better success rate.
Traders thinking of using technical analysis then should make sure that they understand the most important strategies used by other traders. They should practice trades on simulators to identify the theories that both suit them best and match the assets they want to trade before they put down any real money. And most importantly, they should never invest more than they can afford to lose--especially if they're using leverage.
Technical analysis can work and it can be a solution to cryptocurrency's volatility and the difficulty of predicting its long-term trends. But it's complex and it can be expensive.