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Cryptocurrency Trading
by twitter.com/@cryptic_monk
Yet, I couldn't for the life of me, have foreseen the significance, or the monetary
value that Bitcoin would gain over the coming years. If I had, I'd most definitely
have let my PC churn a bit more while it was still possible to mine that sweet
Corn on a CPU. And I'd probably also not have deleted my first wallet so
carelessly.
Life kept me exceptionally busy back then, so I only had time to observe the
developments around Bitcoin from the corner of my eye. Many things happened
that didn't make the space look very good: there was rampant speculation,
gambling, fraud, a proliferation of seemingly useless, low-effort forks of the
Bitcoin codebase.
In 2014, a Russian kid and his friends presented the idea of a new kind of
cryptocurrency that would be, as they promised, programmable. This sounded
appealing to me, but I didn't really understand how they intended to organize
and finance the project. I simply wasn't deeply enough into cryptocurrencies at
that time to bother about the concept of an ICO, and I also wasn't in the spirit of
investing the little hard-earned money I had saved back then.
The space kept evolving. Ethereum went through a boom that found a
spectacular ending in the DAO hack in 2016. Trials and tribulations aside,
promising technology was being built besides and on top of Bitcoin. This
started to give me that feeling I had when seeing my first PC, and later, when
discovering the Internet in the early 90s: everything was still shaky and shabby,
and maybe a bit worse than established lower-tech alternatives, but it could no
longer be denied that there was promise in this new technology, and that it was
here to stay.
Many builders participated in the Internet revolution, but the real money ended
up concentrated in the hands of only a few. This time, things were different.
Every project in the space had an associated token, infinitely divisible, traded
freely on shabby exchanges. You could participate both as a builder, and as an
investor, or in both roles at the same time. This revolution was getting
tokenized!
I had great fun participating in the Internet revolution, but seeing the real money
end up in the hands of Google and Facebook wasn't such a happy ending. So, in
August 2016, I decided to become a small time investor in cryptocurrencies and
started looking for some projects to buy into.
I also soon felt that there was something else. Crypto token prices seemed to
move in cycles that were both quicker and much greater in magnitude than
traditional market cycles, like we know them from stocks for example.
Furthermore, prices seemed to have a tendency to follow trends, or even
memes. There was one coin that made me think particularly hard about this,
DOGE. DOGE didn't seem to have a lot of fundamental merits at first sight.
Development wasn't very active even back then, even the core community saw
it as a cute joke, yet price kept moving in these almost regular cycles, where a
savage price increase of about 4x would be followed by an almost full
retracement, only to be followed again by a savage 4x pump, like clockwork.
Obviously, I couldn't just buy the projects with the most promising
fundamentals. I also had to account for the extremely cyclical nature of crypto
prices, and for the crypto community's apparent eagerness to completely
decouple prices and fundamentals, at least temporarily. It didn't take me more
than three or four 80% losses to learn that.
Cycles in Cycles
That strategy would have worked pretty well, if it weren't for another
idiosyncrasy of the crypto markets: individual coin price cycles are highly
correlated, and there are two big, overlaying cycles: the Bitcoin vs. "all other
coins" (aka. "alt coins") cycle, and the overall crypto market capitalization vs.
fiat money cycle.
Like a sector in stocks that falls out of favor, ALL crypto coins loose value when
the overall market corrects. A bit less common: they all reach similar
percentage losses at roughly the same time, independent of their fundamental
merits - with the exception of Bitcoin that usually loses a bit less. There is a
sub-movement where Bitcoin wins and looses market share (also called
"dominance") against alt coins in a cyclical manner.
While there's a general downtrend in Bitcoin's dominance over the growing
number of alternative cryptocurrencies, Bitcoin market cycles move in the
opposite direction of alt coin market cycles. Bitcoin: upper line, alts
represented here by Ethereum, lower line. (via Coinmarketcap)
While I expect some of this market immaturity to go away over time, for now, we
have to account for it, and the consequence is that there is a time for a crypto
investor to be mostly in fiat currencies, one to be mostly in Bitcoin, and one to
be mostly in the right alt coins. This creates a triple market timing challenge:
timing the overall crypto market cycle correctly, timing the Bitcoin market cycle
correctly, and timing the market cycle of alt coins correctly (augmented by the
challenge of selecting the right alt coins that will participate in the next cycle,
and spiced up by the fact that any alt coin's price frequently goes up 100%, or
down 50% in a single day).
Ripple decided to move today. No fundamentals required (via Coinmarketcap)
Game of Probabilities
By now, it should have become clear that it's impossible to perfectly master this
wild young market. Anybody claiming to be able to do so will soon be trying to
sell you a membership to his paid group.
What we can aim for is to put ourselves in a position where it's more probable to
outperform the market than to underperform it.
If the overall crypto market valuation is reaching new highs after new highs,
or is even going parabolic, we should start to scale out into our preferred
fiat currencies.
Once Bitcoin dominance over the crypto market has been trending
upwards for quite some time, we should consider scaling into
fundamentally sound alt coins.
Once alt coins have been gaining ground against Bitcoin for quite some
time, we should consider scaling out of them.
Once the overall crypto market valuation has retraced considerably from its
former highs (75% for the overall market, 90% for individual alt coins is not
uncommon), we should consider scaling back into the market with fiat.
This is of course a gross simplification of the crypto market's status quo, but so
far, I found it to be a valid basis on which to build my individual approach to
cryptocurrency trading.
We are aiming to time 3 different types of cycles: overall market cycle, bitcoin
cycle, individual alt coin cycles, and combine that with the selection of
fundamentally sound alts. Even with this simplified approach, we will never get
all our entries and exits right.
We will see the overall market go way up while we already partially scaled
out into fiat, or we will see it dump, while we haven't scaled out yet.
We will see Bitcoin gain dominance while we haven't adequately scaled out
of alts yet.
We will buy alts at what we consider low prices, only to see them break
through another 3 supposed bottoms, and grace us with an 80% loss.
We will wait for alts to reach lower prices, only to see them do a savage
300% pump in 5 days.
We will buy alts at the bottom, only to discover that we chose exactly those
few coins that refuse to participate in the next upswing.
As @cryptostardust put it, "shh shh, is oke". If we are too weak for all that, there
are at least two easy ways out: to not participate in the crypto markets at all, or
to buy 2, maybe 5 different coins with sound fundamentals, using a little money
that we can afford to loose, put the coins on a hardware wallet, and check back
in five years. I myself went for a combined strategy: I decided to hold a small
residual portfolio of coins with good fundamentals forever, while trading the
rest, roughly following the method described above.
Now, how can we time those three different types of cycles, at least
approximatively? It's helpful that we are aiming for a high timeframe here. We
are not looking for ephemeral technical indicators to trade short-term technical
reactions. We want to identify the psychological symptoms that drive the high
timeframe cycles at their core: we have to look for other people's feelings of
fear and greed that, in their sum, define the overall market sentiment.
=> These symptoms should lead us to scale out into fiat currencies.
The overall crypto market is likely near a bottom, once the following symptoms
start to occur frequently:
=> These symptoms should lead us to scale into the market using fiat
currencies.
Bitcoin Cycle
The Bitcoin market cycle is likely near a peak, once the following symptoms
occur. Please keep in mind that I am not speaking about Bitcoin price reaching a
top here, but about the dominance of Bitcoin in the overall market, so about the
relative strength of Bitcoin towards alt coins.
Bitcoin maximalists start gloating about all alt coins going to zero
People start quoting low probability targets for Bitcoin dominance, e.g. a
return to 80% Bitcoin dominance
Former proponents of holding a permanent alt coin portfolio become
Bitcoin maximalists or just stop stating their opinions publicly
Statements like "all alt coins are shitcoins", "alt coins have no
fundamentals", "all alt coin projects die eventually", "FA for alt coins doesn't
work" abound
Memetic investor tip of the day: "only an idiot holds alt coins over a
prolonged period of time", "alt coins are only there to increase your Bitcoin
stack"
The Bitcoin market cycle is likely near a bottom, once the following symptoms
occur.
Frequent talk about this or that coin "flipping" Bitcoin (reaching a higher
market capitalization than Bitcoin)
Infighting and depression in the Bitcoin community over loosing ground
towards alts, anger against alts "draining" money out of Bitcoin
Alt coins with the most inane value proposition can reach enormous
valuations overnight
Again, a disregard for fundamentals: "who cares about fundamentals, if it
pumps" (FA is only popular in the middle phase of an alt coin season, when
people flip money from pumped projects to less pumped ones and are
maybe already a bit afraid of the high valuations)
=> These symptoms should lead us to scale out of alts.
In the January 2018 alt coin bull run, Dentacoin, a coin vaguely targeting the
dentist market, reached a market capitalization of more than 2B USD. In
September 2018, its capitalization had retraced by more than 96%, to 81M USD
(via Coinmarketcap)
Altcoin Cycles
As mentioned earlier, the cycles of individual alt coins are highly correlated, but
of course there are still differences in timing and in the intensity with which alts
participate in the so-called alt season, or alt winter.
The "investor" part of the community mostly went silent. Rarely, there are
flare-ups of anger, with ruined investors accusing the team of defrauding
them, not delivering fast enough, not doing enough marketing etc.
Frequent predictions of the project dying, its coin going to 0 etc.
The wider market is no longer interested in or talking about the project,
only a few stalwart investors and, ideally, those directly involved remain. It
seems to be common knowledge that this project is going nowhere.
=> These symptoms should lead us to ask ourselves: "Does this project have
sound fundamentals? Is its currency likely to increase in price if the market
turns in favor of alts?" If yes, we should consider scaling into it.
Fundamental Analysis
I will not present a complete FA framework here, because it's quite easy to
construct your own with the material that is out there. The essence of a good
FA framework is to not only concentrate on the "inner" values of a crypto
project (like the team, the code it produces etc.), but also on its perception (or
chance of being perceived) by the crypto community. As a rule of thumb, I
would say that if your FA framework manages to adequately explain both the
success of Ethereum and the success of DOGE, you should be set.
When constructing your FA framework, don't forget to observe that there are
various fundamental "fads" sweeping through the crypto community. One
month, it's privacy coins, the next, it's Masternodes, and then we see exchange
coins pumping for a while etc. If you manage to spot those fundamental trends
early, bet on the right projects, and get out before the trend is over, you can add
quite a bit of edge to your alt selection.
Another important aspect of alt coin FA is their current and likely future liquidity.
Liquidity helps us get in and out of positions, and low liquidity alt coins can
sometimes have huge price increases when they get listed on a high liquidity
exchange. Low liquidity coins can also frequently be bought at incredibly low
prices because it sometimes takes one single disgruntled investor market
selling to rip through 50% of the buy side on some remote exchange.
More technical aspects of alt fundamentals should be analyzed too - again, I'm
only giving hints here: the coin supply and inflation, the coin holder structure,
major past entry and exit points for holders (e.g. ICOs, airdrops, chain splits, all
time highs, all time lows, past accumulation zones etc.).
Furthermore, it can be helpful to structure the alt coin market conceptually, e.g.
by capitalization: high-/mid-/lowcaps, or by major exchanges: Binance coins,
Bittrex coins..., or by regional appeal: coins loved by Koreans, coins loved in
China, favorites of crypto trading "OGs", or by price cycle characteristics (see
below). While the alt market is highly correlated, over time, an attentive investor
can spot various small undercurrents that can be exploited quite profitably. Alt
trader heaven would be to trade the alt cycles with such high consequence and
deep understanding that the overarching Bitcoin and overall market
capitalization cycles can be ignored.
Risky Business
This comes late in my text, not because it's of little importance, but because
the hints given in this chapter will likely appear boring and commonplace to
most. You've heard it so many times because it's indeed important, and I'm
going to say it again: I see managing risk, or in other words, making sure that,
before everything else, I live to see another day in the market, as my most
important duty. I already implicitly laid out some aspects of my risk
management strategy, let's make them explicit:
By moving from fiat, to BTC, to alts and back, I try to mitigate the risk that
is inherent in the strongly cyclical nature of crypto asset prices: I try not to
hold coins that are at the top of their price cycle and will likely suffer a
rapid price decline soon.
By selecting individual alts based on their fundamentals and on their likely
position in their individual price cycle, I manage two kinds of risks: the risk
of buying coins that are overpriced, and, if this still happens, I at least have
a chance to be in a project that is good enough to see the next cycle and to
allow me to exit there.
By scaling in and out of fiat, BTC and individual alts, I mitigate the timing
risk associated with the triple challenge of crypto/BTC/alt cycles. I move
slowly, which always leaves me a bit of fiat to buy back into crypto, a bit of
crypto to sell out into fiat, a bit of BTC to buy alts, and some alts to sell
back to BTC. I rarely buy a planned position at once because my guess that
a particular coin is now at a bottom could be wrong, and I rarely sell a
position at once, because I could be wrong guessing that it's near a top
now.
Now, this sounds easy in theory: buy fundamentally sound coins when
everybody thinks they're absolutely worthless and will go to zero, and sell them
when everybody thinks they'll moon forever and will soon exceed Bitcoin in
market capitalization. Only that: I am everybody too, and so are you. I too think
that a coin that fell for months and is barely even talked about is actually
worthless and will go to zero, and I too think that with all these new
technological achievements, my favorite new coin will forever moon and soon
replace Bitcoin. In other words: as a contrarian, I have to counteract my own
sentiment, and I don't have to do so in theory, I have to do so when the
sentiment actually arises (provided that I'm more or less attuned to general
market sentiment, which is quite likely if I'm not a psychopath and follow the
market with some regularity). How can this feat of counter trading one's own
sentiment be achieved?
Here are a number of strategies that helped me. Since we are deeply in the field
of psychology now, your mileage may vary, and you might have to find your own
approach to manage your feelings towards the market. The core approach
should always be to stick to the methodology and to not let irrational feelings
lead to irrational actions. The management of our psyche should first of all allow
us to follow our own plan, because, even if we suffer a bit while doing so, as
long as we follow the plan and the plan is good, we should be fine.
So far, I talked about cryptocurrencies like I could also talk about stocks: as
assets, that I buy or sell based on their evolving fundamental value and current
price. Cryptocurrencies however offer far more than that. They are belief
systems, they represent a stake in a network, they can be used to vote, or
simply to gamble, they can be mined, or staked to secure a network, they can
be earned as bounties, or spent for charity, they can even, who would have
thought, be used to pay for goods online, or to program a contract for that little
sports bet we have going with our friends at work.
There are infinite ways to skin the crypto cat, and a serious crypto investor
should explore all of them. This doesn't necessarily mean that every crypto
investor has to become a staking or mining specialist, or has to learn how to
program and use GitHub to contribute to projects, but every investor should
know enough about those subjects to understand their impact on the
fundamentals of the projects he buys into. What price do the miners mine at?
How high is the selling pressure from Masternode owners? Was a big part of
the initial coin supply handed out to serious contributors, or to Bitcointalk
bounty hunters? How easy is it to use the technology that the project develops?
Does it work at all? How good (and sympathetic) is support from the community
when things go wrong? These things matter, and they can be experienced by
anybody involved in the space. Everything is out there, documented, open
source. We need that information and first hand experience to make solid
investment decisions in this emerging field.
Will the crypto wolf capture Bitcoin price movements more precisely? Will the
crypto monkey be more accurate in picking the right coins at the right time?
Will the crypto bird be more aggressive and thus more successful in moving in
and out of fiat?1 Sure. Like any other trader, I can go to Twitter daily and find
somebody who out-trades me in almost all aspects, or at least is able to make it
look as if he did.
The fear that my method could be inadequate, or at least far from optimal, is
always present, and it's often strongest when acting in the market has already
become difficult, when it's time to buy that bottom nobody believes in, or to be
an idiot and sell so low, as everybody says.
When I get this kind of inadequateness FOMO (fear of missing out), I made it
the first rule of the day to not change my method due to that, because flip-
flopping between methods without clear aim appears like one of the easiest
ways to loose money in the markets. I do sometimes try out new methods in a
sandbox (e.g. by allocating a small portfolio percentage to them), and of course
I try to learn from those traders that I found to be both straightforward in their
expression and successful by following them over the years.
In the end, successful trading means abandoning the focus on one's ego and
admitting that we are powerless towards the market, that there are no simple
rules that will work every time, that our actions will often be grossly inadequate,
and our predictions for the future just plain wrong. That the only thing we can
do in the end is try to carve out our very own little niche, and make sure that we
live to trade another day.