Our approach to markets and investment views are based on three key investment pillars: business cycle analysis, valuation analysis and technical analysis.
Whether analyzing mega-cap growth stocks or a cryptocurrency (crypto), we believe it is imperative investors follow a disciplined, repeatable process. Here we explore technical analysis for crypto markets.
Technical analysis is the practice of using price data to identify trends and patterns such as momentum. It is a key component of our investment process that governs the short-term timing of allocation decisions and works in tandem with the qualitative nature of fundamental analysis. Investors use rules-based technical analysis with traditional asset classes such as equities, fixed income, currencies and commodities. Therefore, it should come as no surprise that technical analysis applies crypto markets as well.
Volatility in crypto markets is well documented, making technical analysis useful for capturing inflection points or shifts between positive and negative momentum. However, the sudden volatility that can accompany crypto can present challenges to technical analysis. Furthermore, in the upside-down world of crypto, what would sometimes appear to be a sell signal using traditional technical analysis can often be confirmation of an uptrend and vice versa. For example, the notion of trying to “buy the dip” in crypto has proven costly even for professional traders, giving rise to the term “HODL” in the crypto community, meaning “hold on for dear life.” Buy-and-hold HODLers have come to expect a highly volatile asset class as par for the course, but other investors may be uncomfortable with crypto’s volatile nature.
Investors can approach price momentum analysis with a traditional measure such as the 50- or 200-day moving average (DMA). Another metric investors may use is the relative strength index (RSI), which looks at the closing price of an investment over a short-term period to gauge if it is overbought or oversold by investors at that time.
For example, on December 7, 2017 the price of bitcoin closed more than 230% above its 50 DMA and registered an RSI of 91 (for perspective, an RSI above 70 is traditionally viewed as overbought, and 100 is the highest reading!). Bitcoin peaked shortly thereafter and proceeded to decline more than 80% over the course of 2018. As of January 31 2022, the price of bitcoin is 12% below its 50 DMA and its RSI is 41, suggesting the price of bitcoin is neither overbought nor oversold based on these traditional measures.
Supply Held at Profit
One technical analysis measure unique to crypto markets is the percent of supply held at a profit relative to the market price. It would be impossible to monitor this metric in traditional markets; however, because blockchain data is open source, profitability data is readily available to all investors. When a crypto price reaches an all-time high, the percentage of profitable supply in circulation is 100%. When the percentage diverges from the trajectory of the price, investors can use technical analysis to identify potential opportunities where price sentiment and network strength may be mispriced.
For example, as of January 31, 2022, approximately 66% of bitcoin was held at a profit (despite a 48% decline from the all-time high). In comparison, nearly 70% of ether was held at a profit, even after a 51% drawdown.
Both coins indicate strong network effects — long-term HODLers are not bailing out of the network, even in the face of relatively large pullbacks.
Additionally, both coins indicate there is an immaterial difference in the percent of supply held at a profit relative to recent drawdowns.
Crypto Pairs Trading
Relative trading (trading one crypto in comparison to another) is another common consideration for technical analysis. Let’s consider bitcoin versus ether. Investors can use their price movements against each other as a pairs strategy. For example, during the crypto market selloff in 2018 through mid-2019, the price ratio of ether to bitcoin declined from nearly 0.10 to less than 0.02 (Figure 1). Momentum was flowing into bitcoin and away from ether, resulting in an excess return of more than 200% for bitcoin over that timeframe. Since bitcoin is the largest crypto in the ecosystem, it is another way of describing a “flight to safety” to the largest coin.
Figure 1. Ether to Bitcoin Price Ratio - Last Five Years
As of 12/31/2019 | Source: Bloomberg, L.P.
On the flipside, during the period known as “DeFi summer” in 2020, the price ratio doubled in favor of ether, from 0.20 to 0.40 in the span of less than four months (Figure 2).
Figure 2. Ether to Bitcoin Price Ratio - "DeFi Summer" 2022
As of 9/30/2020 | Source: Bloomberg, L.P.
During that time, ether outperformed bitcoin by more than 100% coinciding with the release of several new crypto protocols using the Ethereum blockchain.
In other words, when the pairs trade favors ether it has historically coincided with outperformance in smaller coins as crypto markets broadly move higher.
We believe all investors should incorporate technical analysis into any investment process grounded in fundamentals. Despite the volatility inherent in crypto markets, there are several strategies, both traditional and specific to crypto, that we believe provide opportunities for investors to use technical analysis in their long-term investment framework.
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Figure 1. Ether to Bitcoin Price Ratio - Last Five Years (view image)
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Figure 2. Ether to Bitcoin Price Ratio - "DeFi Summer" 2022 (view image)
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