How to Trade Cryptocurrency: 4 Methods of Market Analysis

Posted August 11, 2021 by in Lifestyle

At first glance, crypto trading looks simple — buy some coins at a certain price, wait for a while for the price to rise, sell at a higher price, profit. If the price did not surge as expected or even dropped significantly, then it means “no luck”.

Actually, it’s a bit more complicated. Instead of relying on luck, you can analyze the market and think why the price might go one way or the other and whether it is really the right moment to enter the market. There are several methods of market analysis, and despite the constant debate about which one is better, the trader needs to know them all to make a high-quality analysis.

Here are the basic principles of the market analysis methods:

Fundamental Analysis

The idea behind fundamental analysis is to assess whether an asset is undervalued or overvalued. To put it simply, it is an analysis of supply and demand, meaning the change in the ratio of these indicators affects the price movement. The tricky part here is analyzing all the factors that affect supply and demand.

In the crypto world, the situation with supply is quite predictable. There are many cryptocurrencies with a fixed supply and a clear algorithm for reaching the max cap. For example, only 21 million bitcoins can exist in total, each mined block adds a certain amount of bitcoins into circulation, the reward for the found block is halved once every 210,000 blocks or in 4 years. So Bitcoin is becoming an increasingly scarce asset. Thus, if the demand remains the same, Bitcoin can potentially increase in price more and more.

There are also coins where the circulation supply equals the max supply, such as NEO. This means that the price is mainly influenced by the demand change. In addition, With coins like Ethereum that don’t have max supply, it may be necessary to additionally analyze the issuance of new coins.

When it comes to demand analysis, everything becomes much more fun. In this case, you can analyze both internal (hashrate, network activity, average commission rate) and external indicators (trading volume, adoption level, regulators influence). The analysis of on-chain/off-chain metrics and news is the most time-consuming part of fundamental analysis due to a large number of factors. But quite often, it is significant changes in demand that are one of the main drivers of the crypto prices growth or fall.

Technical Analysis

Technical analysis is based on the statement that all current market information is reflected in the market price. Therefore, to determine the probability of further price movement, traders are supposed to analyze how the price moves now and moved in the past.

Technical analysis studies flow, rhythm, and trends in price action. This allows traders to identify similar patterns on the price chart that formed in the past and apply them to current conditions. It is assumed that people behave the same way in similar situations, so history and price momentum may repeat themselves.

For example, if the LTC to USD price could not overcome a certain level several times in the short term, then this may indicate the presence of an important resistance or support level. If the price eventually manages to break this level, it may establish optimism in some market participants and they may push the price further (especially if the market has already faced a similar reaction).

Besides, do not forget that technical analysis is very subjective. If one hundred people look at the same chart, this does not mean that they would all see the same pattern. But the more people see a pattern and trade according to it, the more likely it is that this pattern will be confirmed. It means technical analysis is self-fulfilling as well. 

In the crypto market, technical analysis is predominantly treated with a healthy dose of skepticism. This is because the crypto market is quite volatile and emotional, meaning the situation can change quickly. This often leads to false expectations and irrelevant pattern formations.

However, as the crypto market matures and more historical price data appears, technical analysis may become more valuable in the crypto market.

Sentiment Analysis

Sentiment analysis is used to gauge what other traders think and understand market expectations. Each trader has their own opinion about where the market should go and act according to this position. Collecting information about the opinions of market participants helps form the overall sentiment of the market. Mostly, the sentiment can be bullish (further growth is expected) or bearish (the price is expected to go down). The sentiment is mainly supported by data from fundamental and technical analysis.

The crypto market is dominated by retail investors, so most of the market faces the same issue. No matter how strongly you believe in a certain price movement, you can’t move the market in your favor alone (unless you are some kind of Elon Musk). Therefore, even having a bullish attitude, you need to take into account that the rest of the market can be bearish and incorporate this perception into your trading strategy.

However, it doesn’t mean that you should follow the majority opinion. Quite often, sentiment analysis is used as a contrarian indicator. After all, if everyone or almost everyone shares the same opinion, then this may indicate that the outlook on the market is distorted.

Remember December 2017, when all the media talked about Bitcoin and even grandmas called their beloved grandchildren to find out what bitcoin is. At that time, Bitcoin skyrocketed by almost 10% per day. A lot of people poured into the market, thinking that the growth would never stop and we would see x2 next week. This story reminds us that markets are subject to herding behavior, fueled by fear and greed, making markets periodically under- or overpriced. 

In such situations, it can be useful to act against the market. While this is often a risky strategy, it can be rewarding over time. For example, a few weeks after December 2017 hype a deep price correction began. Those who did not sell on the top had to wait three years before the price updated the all-time high.

Hybrid analysis

The main argument of hybrid analysis is that one market analysis method is not enough for successful trading. Hardcore supporters of fundamental and technical analysis always argue about the value of their method (while fans of sentiment analysis are observing their battle). But focusing on only one analysis method gives a very limited view of the market.

Different types of market analysis complement each other. Fundamental indicators can shape market sentiment, established sentiment develops trends that are analyzed by technical analysis adepts. If you want to get the most out of trading, you may need to find a balance in attitude towards analysis.

*Photos by Karolina Grabowska