Can Technical Analysis Be Used to Analyze Cryptocurrencies? (Bitcoin, Litecoin, Peercoin, et. al)

Novelty bitcoin image

Pile of novelty Bitcoins

 

With the swift and steady rise of cryptocurrencies, most notably Bitcoin, it is little wonder that the media and professional investors are taking note. The media has aggressively increased its coverage on Bitcoin during and since November 2013 when the price of Bitcoin rocketed nearly five-fold from $200 to over $1,000. Since November, the price has fluctuated between over $1,100 and roughly $500. Bitcoin can currently be purchased for approximately $800 at the time of this writing, though I always laugh when I read prices quoted at publishing date months, weeks, and even days later (Since they are always so far off the mark from the current trading price). By the time you are reading this in the future, it is highly likely that Bitcoin will be worth well over $800 or far less than $800, which brings me to my next point and question:

 

Can Technical Analysis be applied to analyzing crytocurrencies for decision-making criteria, broad market assessment, and forecasting?

 

To answer this question, we will need to first return to the basic fundamentals of Technical Analysis (pardon the pun). It may not be obvious that Technical Analysis can only be applied to instruments that meet certain requirements, and it may also not be obvious that cryptocurrencies may fall outside of those requirements. In order to analyze crytocurrencies, we will first need to define the basic market requirements for applying Technical Analysis as defined by Dahlquist and Kirkpatrick in their work Technical Analysis, the Complete Resource for Financial Market Technicians.

 

The four types of markets are given as follows:

 

Direct Search – this market requires a buyer and a seller to “seek” each other out. Examples of this type of market include the “Classifieds” section of a newspaper, or the popular online direct search website Craigslist.org.

 

It is possible for digital currency buyers and sellers to employ a “search and seek” method to their transactions whereby they collectively or individually introduce themselves and attempt to negotiate a transaction with other willing participants. This is often done through email or by messages on various cryptocurrency forums, and trust is often based on the reputation (quantified by certain sites or otherwise) of each party.

 

Brokered Market – this type of market is facilitated by brokers who bring buyers and sellers together. The largest example of a brokered market is the real estate market. These brokers usually get a commission for their services.

 

These types of markets exist for cryptocurrencies, most notably the site www.localbitcoins.com, based out of Finland, offers a direct search market for those that wish to buy and sell digital currency both online and in person. The site can match your location by your IP address and shows you all local users who are either buying or selling Bitcoins for cash. For online transactions, currency is stored in an Escrow account until payment has settled, and for this reason the vendor is considered a brokered market bringing two or more parties together to facilitate a transaction.

 

Dealer Market - the dealer market is characterized by dealers who offer bid prices to potential sellers and ask prices to potential buyers of their wares. The dealer market differs from a brokered market because the dealer is actively buying goods himself/herself. Examples of a dealer market include pawn shops and the Nasdaq.

 

Dealer markets also exist for cryptocurrencies, most notably exchanges such as BTC-e (https://btc-e.com/) and Bitstamp (https://www.bitstamp.net/). In these exchanges, the vendor assumes the liability for a certain number of coins and offers to buy and sell them out of their inventory at a bid/ask spread based on users’ orders and market flow.

 

Auction Market – the most freely traded of all markets, the auction market is characterized by a central meeting place in which buyers and sellers simultaneously interact with each other. The meeting place can be physical or over the Internet. Not surprisingly, the NYSE offers both. It is the ultimate auction market. Ebay is another example of an online-only auction market.

 

The Auction Market would likely be a first for Bitcoin and other Cryptocurrencies, having no known prior auctions for the currency. However, with the Fed ready to sell it’s haul of seized Bitcoins from former underground wares site Silk Road, we could see a first-ever Bitcoin auction in the very near future.

 

Market Requirements

 

Markets must meet certain characteristic requirements before technical analysis can be applied. In order to apply technical analysis one needs previously recorded price data. Data on volume, the number of transactions that took place on a given day or at a given price, is helpful but not required. Below are the characteristics that are required to apply technical analysis, according to Dahlquist and Kirkpatrick:[1]

 

Easy access – low barriers to entry and exit that allow people to come and go freely

 

Currently, all one needs to buy a Bitcoin is a bank account with ample funds and access to the internet to access digital coinwallets such as Coinbase.

 

Fungibility –any “good” or investment must have identical “counterparts” that are always equal in price and what they represent. One share of Wal-Mart is identical to the millions of other shares of Wal-Mart, for example.

 

One Bitcoin is always one Bitcoin, and can be sub-divided by up to 8 decimal spaces, making the currency easily added, subtracted, and standardized.

 

Sufficient liquidity – this allows transactions to take place freely and continuously so that buying and selling can take place anytime the market is open

 

While liquidity was not always present in cryptocurrency exchanges, especially some of the smaller obscure exchanges, there is sufficient liquidity on the largest global exchanges and transactions occur in real-time often every few seconds with ample volume.

 

Continuous trading – in the sense that the market is open consistently, day after day, as opposed to intermittently or sporadically – for example auction house auctions. (auction items typically lack fungibility as well)

 

The Cryptocurrency marketplace never closes, ever. It is open for business 24/7/365 without failure. In the recent past certain exchanges (most notably Mt.Gox) have been hacked and their servers shut-down temporarily, however in these cases trading has fluidly and easily moved to any of the other numerous exchanges and business vendors that exist.

 

Conclusion

 

Based on the above fundamentals of Technical Analysis and the corresponding cryptocurrency responses to the various requirements, Market Tech Lab concludes that digital currencies such as Bitcoin are suitable to be analyzed by Technical Analysis using normal and traditional methods of study. Some smaller cryptocurrencies may not have sufficient history or liquidity at this time, however may meet these requirements in the future. One thing is clear – Bitcoin and Technical Analysis are a match made in Heaven.

 

Bitcoins and Bitcoin Logo


[1] Dahlquist, Kirkpatrick p.56