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1/ A Better Way to Invest in Digital Assets
Crypto assets… they’re intriguing to many. Many say it’s all voodoo. Others say, “It’s for the kids, but not for me.” Even more say, “It’s not safe – there’s no way I’d invest in that stuff!”
I hold a different opinion. There is no underlying asset in these crypto-currencies, which means they trade solely on supply, demand, buying power, and selling pressure. Said another way, investing in digital assets is about as “behavioral” as “behavioral finance” gets, which means these investments are great for technical analysis and trend-following.
Now, let’s get one thing out of the way… I said “Trend-following.” I did NOT say “Trend prediction.”
Unless you’ve figured out how to build a time machine that works (and will get you back home), there is no such thing as trend-prediction. No one can predict what any investment is going to do tomorrow, next week, or next month.
So, whenever you hear technicians talk about trend-following, always know that they’re following the trend, which means there is no way to get all the upside and avoid all the downside. THAT is voodoo!
Alright – now that we have that behind us, let’s look at using technical analysis as a better, safer way to invest in digital assets…
2/ Bitcoin vs. Ethereum
This first chart is something called a “Relative Strength Chart.” It is NOT a chart of Bitcoin or Ethereum. Instead, is a comparison between the two.
Notice the first symbol I inputted in the upper-left corner ($BTCUSD). This means that, when the chart is trending up, that means Bitcoin is exhibiting higher relative strength (or “RS” for short). Furthermore, when the chart is trending down, it means that Ethereum is exhibiting higher RS vs. Bitcoin and could thus be the better investment (between the two) to own at that time.
Determining the trend on an RS line chart can be tricky, so to make things a little clearer, I inputted a 150-day moving average (150MA) onto the chart so that pivot points in strength could be easier identified. In other words, when the chart is “under water” (in blue), ETH is the higher-RS investment. When it’s “above water” (not in the blue area), then BTC is the higher-RS investment.
One of the ways to succeed in investing is to stay invested with strength and avoid laggards. Reason being, many studies have been done that suggest relative strength tends to persist, and momentum tends to continue over the course of 6-12 months, on average. Again, it’s not perfect (nothing is!), but this is just one way to determine which of these two crypto assets are the strongest at any given time.
3/ Point and Figure
Another way to observe RS is to use a Point & Figure (PnF) chart. While it’s not as intuitive, there are two things I love about PnF charts:
- Pivot points are clearly defined by buy or sell signals, which take place whenever there is a higher-high (in X’s) or lower-low (in O’s), and
- PnF charts have no “time frame.” In fact, the entire concept is time is removed from the chart when looking these charts, which means that we’re focused solely on RS without the “noise” of time to distract the analyst.
The PnF chart above uses what’s called a “3-box reversal method,” which means that price has to rise or fall by “three boxes” (look to the left or right) in order for the relatively strength to weaken or strengthen.
From there, when you get an X printed at a higher place than the previous X, this is called a “buy signal,” and in the case of an RS chart like the one I created above, the buy signal would be a lot like the line chart (in Figure 1) being “above water,” except in this case, instead of a moving average over time, there is no time… so we’re simply observing price movement.
Conversely, if the chart prints a lower low (i.e., an “O” is printed lower than the most previous “O”), then that’s a sell signal… and again, because this is an RS chart, this “sell signal” would mean that ETH is the stronger investment between the two.
So again, one of the keys to investing is staying invested in what’s stronger at any given time, and this is a 2nd way to observe relative strength.
I reiterate – is it perfect? Nope… just like the line chart (in Figure 1), there are times (like the 2nd and 3rd quarter of 2020) when you can see buy signal – after sell signal – after buy signal. Sometimes relative strength is “trendless” and it can get frustrating to stay invested in “what’s strongest” when it’s changing all the time…
…and THIS is why it helps to have a second type of filter outside of RS to protect you from catastrophic losses (continue reading).
4/ A Closer Look at Bitcoin
Let’s hypothetically say that we’ve implemented the use of an RS chart and we know that BTC is the stronger of the two investments. We could simply own the stronger of the two at all times, couldn’t we? Of course!
However, what would be the drawdown in this strategy? The answer: The drawdown would be… well, “drawdowns.” (ahhhh, a play-on-words in an article on technical analysis and charts – how refreshing!).
What I mean by this is, if we merely own the stronger of the two investments, all is fine and good as long as they’re going UP! However, if we own the highest “relative” strength asset in question, both could still be going DOWN on an absolute basis (or as I like to say, “we just own the cleanest dirty laundry” in that case!).
To fix this problem, we can choose to use a moving average to define trend. In the above chart, I used a weekly timeframe with a 40-week moving average (which is mathematically the same as a 200-day moving average on a daily chart, for the nerds out there). 😊
So, if BTC is the better investment on a relative basis, the next thing we might want to do is pull up BTC on its own, throw a 40-week moving average on the chart to define trend, and if it’s above that line, we could consider that “Risk on” (i.e., we own it), and if it’s below that line – or in my charts, I use “shaded areas” in blue because I like to think of a downtrend being “under water,” and if that’s the case, we don’t want to own it any longer.
Now, one downside to trend following is sometimes you get something called “whipsaws.” This is when the trend changes multiple times, back & forth, causing you to sell, buy a potentially higher prices, only to sell again at lower prices.
While this is extremely frustrating, recall that we can’t have it all… we can’t have ALL the upside and NONE of the downside. That, again, would be “trend prediction,” so whenever using trend-following, we have to be willing to take the good with the bad, and sometimes, we get whipsaws and “that’s just how it is.” Get over it, follow your rules, and move on.
5/ A Closer Look at Ethereum
This time around, I pulled up an Ethereum chart, just to observe the times when the trend would be up vs. down, when the investor might be invested vs. sitting in cash (or other investments, for that matter).
Notice that sometimes, you latch onto a nice, long trend, which is awesome. Then notice that sometimes, you get whipsaws, and you just have to get through those choppy time periods when trend-following doesn’t work so well.
Just remember, there is no investment strategy that works ALL the time – but a good, sound, robust, tested strategy will work OVER time.
6/ Dogecoin
Just for fun, I thought I’d pull up a chart of Dogecoin – the cryptocurrency that was started (quite literally) as a joke. Two software engineers wanted to start a digital asset that would be “fun” and more widely accessible than Bitcoin, and they named it off a popular “Doge” meme at the time, which features a Shiba Inu dog as its mascot. <I’m shaking my head as I type this>
Dogecoin did get pretty popular over time. It was endorsed by Elon Musk at one point (which certainly helped), it was used as a funding source for social media platforms, charitable and supportive ventures, and was even used to fund Olympic athletes.
If you look at the chart above, however, you can clearly see that it’s a volatile digital asset, and not for the faint-of-heart. Still, adding a 200-day moving average, you would’ve been whipsawed quite a bit in 2018, 2019, and 2020, but there were also times when you could’ve ridden a nice wave and then cut bait before things went parabolic (to the downside, that is).
At the end of the day, there is a plethora of technical indicators and overlays one can use when analyzing and trading the markets. Today, I just wanted to share how two, very simple concepts can make investing in what most consider to be a pretty risky asset class, not so scary after all!
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Originally posted on March 13th 2024
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Disclosure: Digital Assets
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