How Crypto Markets Differ from Traditional Markets
Cryptocurrency markets do not follow traditional trading hour structures. Instead, cryptocurrency assets trade at all times around the world on numerous exchanges with varying degrees of regulatory oversight. This continuous trading contributes to the high frequency and magnitude of price changes experienced by cryptocurrency markets.
There exists significant variation in the liquidity of cryptocurrency assets. Cryptocurrencies with large market capitalizations generally have larger and more liquid order books than cryptocurrencies with smaller market capitalizations. The differences in liquidity among cryptocurrencies can affect the formation and duration of trends in the cryptocurrency markets.
Another major difference between cryptocurrency markets and traditional financial markets is the level of transparency in each type of marketplace. While some types of financial data available through public sources are limited in terms of detail and scope, most blockchain-based cryptocurrency networks allow analysts to publicly monitor on-chain activity in conjunction with price data. Therefore, there is significantly more data available to analysts in cryptocurrency markets than in traditional financial markets.
Understanding Market Trends
A trend refers to the overall direction of price movement of an asset over time. Trends can appear and disappear rapidly in cryptocurrency markets, but the concept of trends remains a key component in the analysis of cryptocurrency markets.
When prices are making higher highs and higher lows, the market is considered to be trending upward (also referred to as an uptrend). Conversely, when prices are making lower highs and lower lows, the market is considered to be trending downward (also referred to as a downtrend). A sideways trend exists when prices are trading within a narrow price range.
As noted previously, trends do not exist at a single point in time. Trends exist across different timeframes. Therefore, a short-term downtrend can exist within a longer-term uptrend. Analysts may analyze multiple timeframes simultaneously in order to gain perspective and context regarding the trends present in the cryptocurrency market.
Factors That Influence Trends
Trends remain active as long as there remains a source for continued support from those who have created the trend. When the pressure to buy or sell lessens, trends may weaken or turn around.
- The overall network environment and the protocol will usually drive the long term sentiment for a particular cryptocurrency.
- Regulatory announcements can shift the trend very rapidly, especially if the announcement is negative.
- As well, the inflow or outflow of liquidity into/out of the market can increase/decrease the trend's strength.
- Ultimately, larger trends will always be affected by broader market conditions which will directly impact the level of investor risk appetite.
Market Cycles in Crypto
Crypto markets are generally cyclical rather than linear. The cycles represent a progression of participant behavior through time. Each cycle is different as far as length and intensity, however, similar phases occur in every cycle.
Typically, early cycles represent an accumulation phase, in which prices stabilize as they recover from prior losses. Then comes the expansion phase, in which increasing interest drives prices higher. Next is a distribution phase, in which some of the earliest participants begin to liquidate their positions. Finally, the contraction phase begins as the momentum behind the trend continues to dwindle and eventually fades completely.
Common Cycle Phases and What They Mean
The cycles are determined by a combination of exogenous factors (macro economic conditions, advancements in technology, availability of capital), as well as endogenous factors (the schedule of token issuance).
- Accumulation represents periods during which the price stabilizes as it recovers from previous declines.
- Expansion refers to periods of growth and increased participation driving prices higher.
- Distribution is the period of reduced participation and slowing upward momentum.
- Contraction is the final stage in the cycle, representing a reduction in participation and a decline in prices and trading volume.
There is no set timeline for these cycles, analysts look at the behavior of the participants, and not the time frame, when determining the current phase of the market.
Volume and Liquidity as Signals
Volume is defined as the amount of a particular asset being traded within a specified time frame. In cryptocurrency markets, the volume of a particular asset has the ability to confirm or contradict price movement. Strong volume in conjunction with rising prices indicates that many participants are involved in the trade. Conversely, rising prices with decreasing volume suggests that there is a decrease in momentum.
Liquidity describes the ease with which an asset can be purchased/sold without having a significant price impact. Markets with high liquidity are able to easily absorb large transactions, whereas low liquidity markets are subject to greater volatility due to the smaller number of participants.
Many analysts pay close attention to both the changes in the volume of a particular asset, as well as the changes in its liquidity levels. A sudden increase in either one can indicate a reaction to news or a change in the structural positioning of the market participants.
Price Structure and Support Levels
Historically, price has reacted at certain levels referred to as support and resistance. Support is typically the area of price where buyers have been able to slow down a decline in price. Resistance is the level where sellers have been able to limit an increase in price.
These levels of support and resistance are not specific price points. Rather, they are zones of influence created by historical price action and the "memory" of participants in the market. By studying how price acts near these levels of support and resistance, analysts can gain insights about the strength or weakness of price.
If price breaks through a level of support or resistance with significant participation (volume), this could signal a change in the underlying structure of the market. Breakdowns and failed breakout attempts can also give analysts insight into what type of sentiment exists in the market.
Technical Indicators and Their Role
Technical indicators take the raw price and volume data available and transform it into visual aids that allow analysts to see the momentum, volatility and trend strength of price. Indicators themselves do not forecast future events; however, they can provide valuable information and context for the analyst.
Each technical indicator serves its own purpose and therefore is used differently. For example, some indicators smooth out the price data in order to make it easier to analyze the trend of price, while others measure the speed of price movement or how far away from the average price the current price is. Typically, analysts will use a combination of indicators so they will not rely too heavily on any one signal.
Common Indicator Categories
There are many categories of technical indicators. The main categories include:
- Trend indicators assist in identifying the trend of price over a longer period of time.
- Momentum indicators measure the speed of price movement.
- Volatility indicators measure the degree of price fluctuation.
- Volume-based indicators measure the intensity of participation in the market.
Moving Averages and Trend Context
Moving averages smooth the price data by taking the average of the closing price over a predetermined number of periods. Moving averages help to remove random fluctuations in price and reveal the overall direction of price. The shorter the moving average, the faster it responds to price movements. Conversely, the longer the moving average, the slower it moves.
When the price of a stock is trading above a moving average, it is generally considered a positive indication of the bull trend. Conversely, if the price of a stock is trading below a moving average, it is generally considered a negative sign of the bear trend. When the short-term and long-term moving averages cross over, it can indicate a change in the direction of momentum.
Therefore, analysts view moving averages as reference points and not as hard and fast rules.
Momentum and Relative Strength
Momentum indicators evaluate speed (how fast prices are moving). Strong momentum (a fast-moving price) is likely to be associated with the continuation of an existing trend. Weakness in momentum (prices slowing down) typically occurs prior to a period of consolidation or a reversal in trend.
Relative Strength Index (RSI) type indicators provide a comparison of recent gains versus recent losses over a set timeframe; they help identify whether current price movement will continue in one direction or reverse.
The use of these indicators is heavily dependent upon context. Strong momentum can last longer than anticipated within the confines of a speculative environment.
Volatility and Market Behavior
Volatility refers to the rate at which price movements occur over time. The crypto marketplace is well-known for having high volatility (price fluctuations), especially during times of increased speculation or uncertainty.
Historically, low volatility has preceded significant price movements. Analysts have traditionally been able to recognize when there is compression in price range (i.e., a narrowing of price movements) indicating that a larger move is imminent.
As mentioned above, volatility itself is neutral. Volatility is indicative of the level of uncertainty and/or the amount of opportunity present; however, it does not indicate direction.
On-Chain Metrics and Network Activity
On-Chain Analysis uses data recorded directly onto blockchains (i.e., transaction volume, active addresses, etc.). On-Chain Analysis also tracks asset movement between wallets and exchanges.
Metrics from On-Chain Analysis provide analysts with a view of how the blockchain network is being utilized, as well as the behavior of users/participants. Increasing On-Chain Activity may indicate increasing interest in a particular cryptocurrency. Decreasing On-Chain Activity may indicate decreasing interest in a particular cryptocurrency.
In conjunction with price analysis, On-Chain Analysis provides analysts with a structural view of how cryptocurrencies are being utilized as opposed to simply evaluating their price.
Sentiment and Market Psychology
Market Sentiment represents the collective emotions of investors/traders. Market Sentiment in the crypto marketplace can shift rapidly due to the vast amounts of social media chatter, news articles, and public commentary.
High levels of extreme optimism may coincide with a "late cycle" in a trend. High levels of extreme pessimism may coincide with a "bottom" in a trend. Analysts review Market Sentiment indicators to gauge how far away from rational thinking investors/traders are.
While Market Sentiment does not dictate price alone, it does affect investor/trader reaction to information.
Limitations of Market Analysis
Crypto market analysis may be limited by unanticipated events, which can supersede previously established price patterns, and by liquidity shock that can eliminate previously identified technical structures.
Also, data quality varies from one platform to another. Therefore, there are differences in volume reporting as well as in market structure and therefore the ability to accurately interpret the data.
Knowledge of these limitations will help in maintaining realistic expectations regarding the use of analysis, and analysis is an observational tool and not a certainty tool.
Understand How the Market Functions
Crypto market analysis is about analyzing trends, cycles, and indicators, etc., based on all the available information in the marketplace. Price movements reflect what the participants in the marketplace collectively believe, what the structural forces in the marketplace are, and the direction of the sentiment of the participants.
There is no single tool or indicator that can explain everything. In order to get a better understanding of the marketplace, analysts use multiple tools and methods to analyze the same market.
The purpose of market analysis is not to predict future price movements, but rather to understand how the marketplace functions, and why it moves the way it does.