Low tech vs. High tech. Can simple techniques find an edge?
“As far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.”
― Albert Einstein
The more uncertain you become, the more likely you are to do nothing. And as you do nothing, opportunity passes you by. There are windows of time to act when speculating in the cryptocurrency markets. Miss them, and your edge slips away. The majority, the 95%, miss out because they look around for guidance from others. They visit chat rooms, twitter feeds, facebook, anywhere to give them a clue.
The masses do almost everything, except what is required to be consistent and successful in speculation.
Missing a move, they wait until tomorrow to buy, because they can’t believe it’s gone up and they think they’ll be able to pick it up on the cheap. Underwater and losing money, the pain is intense. They wait until tomorrow to sell at a higher price because they can’t believe it’s gone down so fast.
But tomorrow never comes.
Have you ever seen a poker player go full-tilt?
Played tight, running the odds and winning; the world is a good place. For some, all it takes is a bad beat. Bluffed off the winning hand by a bad player, or losing to a player who had nothing and lucked into kings full on the river is all it takes for our humanity to show.
The discipline melts away, replaced with the need to get their revenge. All the tools required to win are thrown out of the window. Probability, money management: all gone. In their place, anger, frustration, and the need to get back to breakeven.
They fall for bad players who have no idea what they’re doing, players who’re doing the right thing entirely by accident; calling on the flop, check-raising the turn, and bombing the river.
Before long the well-disciplined player is replaced by an angry, irrational monster, who’s swinging for a home run on every hand and abandoned everything they know about the game.
And that’s how it happens, that’s how good players go full tilt.
They play without the tools that are required to win.
Instead of playing the numbers, instead of playing poker, and instead of doing the things that made them successful; they’re doing this.
This is when the damage is done. Loans are taken. Fortunes are lost. A player on full tilt will do anything to get to even. Then boom!
This behaviour is not limited to poker. It happens when speculating in cryptocurrencies too. The 95%, the majority of market participants, go broke trying to win back their losses and get back to breakeven.
Deus Ex Machina
Why keep it simple if you can make it complicated?
If you had to pick one tool to represent the mindset of the 95%, the number one choice is the trading bot. These tools are often promoted with pictures of friends relaxing in bars, restaurants, and coffee shops. Attractive people, laughing and smiling; a text comes in, and she picks up her phone. While keeping the gaze of her friends, she casually taps a button. With a look of certainty and satisfaction, she places the phone immediately face down on the table, and carries on her conversation as if nothing has happened.
Trade done. Look how easy it is, and, by presupposition, how easy it is for you too. The majority of buyers in cryptocurrencies have been burned. Yes, some people have made life-changing fortunes. They’re the ones you hear about. Stories like the clueless guy who bought thousands of Bitcoins when they were going for pennies, but the truth is most people who’ve attempted to trade cryptocurrencies, like the majority who piled into the stock markets in the late 1990’s or the ones who jumped aboard the forex gravy train, lose.
What about the speculators you don’t hear about? What happens to the people who give it a shot and do the opposite of winning, because they’re human and suffer from a heady cocktail of built-in biases?
Some run away, and never touch the markets again. Some don’t. Some driven by the promise of a perfect life, go in search of Nirvana. The rewards, if they find the key, is a perfect life. A life where the currency is not the dollar, euro, pound, or yen, but freedom.
The problem is, freedom comes at a cost.
Industry-leading automated trading systems cost anywhere from a few hundred dollars to thousands of dollars per year. And it doesn’t stop there. One trading bot company even uses a multi-level marketing business model.
Letting these freedom creating trading robots loose on your cryptocurrency account does not come free. You’ll pay hefty subscription fees unless you’re computer savvy, and if you use the free open source versions, you’ll still have to pay. Not with dollars, but with your time.
Then there’s the complexity of the order types and the maintenance of the system. If you use an automated trading bot, you’ll still have to learn how to use it. Pull back the veneer though, and you’ll find many moving parts. It’s like spinning plates.
The majority of people are attracted to complex solutions, like using trading bots to make their trade decisions, because they are time-starved and they are sold on the idea that automation will solve this problem. Often, it’s because they want a fast solution to their real problem.
But they put little thought into how or what the automated system is actually doing. A trading bot is just a collection of algorithms. A set of rules to take advantage of specific market setups.
Arbitrage, market making, trend following, and volatility. These are the big four conditions trading systems typically attempt to make profits from.
The 95% are attracted to these tools because of the “What if” potential.
What if they could give up their job? What if they could travel, and work from home? What if they could spend more time with their families and friends? What if they could live the life they want? The life they were promised if they studied and worked hard.
The potential of their future life blocks out the nagging questions, and in a moment of decision they jump in and buy the automated black box.
Blinded by the promises of the life they desire, they don’t stop to think; apart from them, who else uses the same collection of algorithms?
They don’t stop to ask; what would happen if this trading bot is the most successful trading system ever devised?
They don’t think to ask; why have they been given the opportunity to use this money making and life-changing machine. Why, if the edge is so good, didn’t the developers keep it to themselves and quietly make millions?
Invested in their new automated system, they learn how the trading bot works but not how the market works. It’s like they’ve been abstracted away from the knowledge they need to understand the one critical component of successful speculation.
Instead of using a black box of algorithms and relying on god out of the machine, they could spend their time and energy learning the direct causes of arbitrage situations, trends, widening bid/offer spreads, and increased levels of implied volatility. But they don’t.
What if, instead of investing time and money learning an automated system, coded by someone else, and sold to the masses, they instead put their energy into how the market actually works?
What if they replaced the complexity of Deus Ex Machina with a simple schematic model that can be overlaid on any financial market from the Russian rouble to the T-Bond; from Bitcoin to Cardano, and everything in between?
In China Crisis, we discussed a technique Enrico Fermi used to guesstimate a result. We asked “How many piano tuners are there in Chicago?”, and by starting with three simple questions, we came up with 225. (The answer, according to Wolfram Alpha was 290.)
Engineers reading this might be pulling a face around about now. They are used to exact calculations, and they have trouble adjusting to all this guesstimating. But this isn’t aircraft design. It’s a financial market schematic. In financial speculation you don’t need to be right all the time, in fact, you don’t even need to be right most of the time.
The majority of traders, the 95%, place their focus and energy into trying to be right. It’s their first major mistake. This is one reason why the 95% spend so much time searching for the perfect system. It’s why they invariably give up on a trading system because they are disappointed with their results. The 5% club’s secret: There are no perfect systems.
The 5% club, the consistently successful, don’t waste their time and energy trying to be right. They know this is futile. In financial speculation, including cryptocurrencies, trying to be right is like sitting on a beach trying to hold back the tide. Don’t try. In the end, you’ll drown.
California 1849: There’s gold in them thar hills. Who made the most money during the gold rush of ’49? Not the miners. Nope. Most of them died broke.
Some equipment and “hospitality” providers made fortunes, but the most successful was the food wholesalers because it takes a lot of energy to swing a pick and shovel. Have you ever owned a pair of jeans? Levi Strauss made his fortune during the Gold rush of ’49. Not from gold mining, but from selling dry goods.
Anyone selling you a system is in the business of being Levi Strauss. It’s a smart thing to do. Think about that before you invest thousands in a system that’s being sold to you as a way to solve the biggest problem in your 21st-century life. Your freedom.
Building a Killer App
Instead of trying to be right, the 5% build a schematic model of the market they’re interested in trading. Yes, some of the 5% automate their edges after they’ve discovered an advantage, but a lot of them don’t. The 5% build their schematic using simple old-school tools. You don’t need the latest computer systems, and you don’t need the newest iPhone. Here’s a list of what you do need.
A sheet of paper.
To start building a model of a market, you ask simple questions. By asking the right questions, you’ll understand the context of where the market you are looking at is, concerning trend.
First, the 5% club assume all markets move in cycles between an uptrend and a downtrend. Markets don’t trend all the time, in fact, a lot of the time markets don’t trend at all. Some markets can spend years transitioning between an uptrend and downtrend and vice versa.
Time to get right-brained. Think of a market cycle as having 4 states, Zero, one, two, and three. State one is an uptrend, and state three is a downtrend. State zero is a transition period between the previous state 3 downtrend and a new state 1 uptrend. State 2 is the transition period between a previous state 1 uptrend and a new state 3 downtrend.
Take a look at the chart of Bitcoin. What state would you say Bitcoin is currently in? Zero, one, two or three? It’s easy to place Bitcoin in state zero, using this simple model.
You might be asking if there are any clues on a chart that give the 5% club direct market feedback that a down move (state 3) is about to transition into a sideways movement. (state zero)
In previous articles, podcasts, and videos, we’ve discussed how the 5% club use price action to indicate when a market moves from random to less random. We discussed the emotion bar, a wide range bar, (compared to the bars preceding it), with high volume and a close around halfway back into the range of the day.
Let’s build on this concept and fit emotion bars into the schematic. Emotion bars represent the “corners,” the times when a down move is most likely to pause and rally or pause and trade sideways.
The idealised schematic looks like this.
And this is Bitcoin. The February the 6th low represents a possible transition from state 3 to state zero.
And this is how you build a schematic. Start with the premise that markets move in cycles between downtrends and uptrends. And then, instead of using technical analysis the way it’s taught to the 95%, use it as a proxy for the behaviour patterns of the masses.
The 5% club use this technique to gauge when the market is going to pause or change direction. An emotion bar represents the masses throwing in the towel and giving in to the pain of loss. They literally can’t take it anymore, and they’ll do what they need to do to end their suffering.
The power of building a schematic using this technique is the low tech (and free) method used to construct it. It would take a very sophisticated and complex set of computer algorithms to build this complete schematic digitally, and the cost would put it beyond most retail traders.
So far we’ve discussed a framework. A skeleton structure for market speculation. In its idealised form, all markets move between down trends and uptrends. We’ve also discussed emotion bars and where they fit into the schematic.
Emotion bars represent a pattern of human behaviour. They are used to signpost the ending of moves, both up and down. Before we continue, it’s important to understand what causes emotion bars.
Here’s a useful saying the 5% club use to keep them on the right side of a market.
“Frenzies don’t begin trends; they end them.”
It’s always been this way because this behaviour is driven by our built-in biases. This behaviour pattern applies to up moves and well as down moves.
In recent history, upside frenzies drove the Nikkei index in Japan to an all-time high in 1989. The Nasdaq tech bubble high in 1999-2000. The stock market highs of 2007. And it’s not just stock indexes. The highs in gold and silver in 2011, The Euro/USD exchange rate in 2007, crude oil in 2008, and of course, Bitcoin in 2017. All highs accompanied by frenzies.
Frenzies aren’t reserved just for uptrends. It’s in down trends where frenzies come into their own.
The British pound collapsed after Brexit in 2016. The media wheeled out the usual impressive sounding experts. The consensus was for parity with the US dollar. On the 7th October 2016, the only way was down for the British pound. A masterclass in throwing in the towel.
And that was the low. An Emotion bar. A wide-ranging bar on 270% of average turnover that closed in the top third of the daily range.
The 5% club know…
When the only way is down; then, the only way is up. And Vice versa.
Frenzies don’t begin trends; they end them.
The 5% club understand when they see the media getting behind a story when everyone is trying to get a piece of the action, and when the only way is down, the probability is for the opposite to happen.
These frenzied behaviour patterns are everywhere. History is littered with them. Take the time to look.
Now you have a schematic, an idealised way to represent a market state, you’re going to need to decorate it. We’ve already talked about emotion bars and the frenzies that cause them. And we know where emotion bars fit into the schematic. They occur at the transition points.
The 5% club expect emotion bars to occur as a market transitions from a down move (state 3) to a sideways move (state zero) and from an up move (state 1) to another sideways move. (state 2)
Let’s start calling these states by their real names.
A down move (state 3) is a downtrend. When a market transitions, via an emotion bar, from a downtrend into a state zero sideways move, it’s called accumulation.
An up move (state 1) is an uptrend. When a market transitions, via an emotion bar, from an uptrend into a state two sideways move, it’s called distribution.
When a market moves through the cycle, from downtrends into accumulation, and from uptrends into distribution, it leaves behind the signatures of human behaviour.
The base set of emotions show up in the following behaviours: Emotion bars, automatic rallies, automatic reactions, and secondary tests.
There are a few more, but the base set of traits will give you 80% of the vision range required to read any market — using only four behaviour patterns.
Fitting these behaviour patterns within an idealised schematic, allows the 5% club, to build a systematic story of what is happening to a market.
Coding the schematic would be beyond 99.99% of people unless of course, you’re a trained programmer. Most aren’t.
Instead of buying a black box of systems, instead of relying on entries and exits from a system designed by someone else, you can use a simple schematic of four states and four behaviour patterns.
When you build a storyboard of behaviour patterns using the simple schematic of downtrend, accumulation, uptrend, and distribution, what you’re really doing is analysing the supply and demand of a market.
In the Shapeshifter series, we talked about how the MIT blackjack team assigned values to cards to give them an edge. By keeping track of the count, the MIT team knew the moments in time when the probabilities within the game swung in their favour.
A single low-value card, a four of diamonds, wouldn’t give them any useful information when taken in isolation, but when, over a series of cards, the ratio of low-value cards being drawn was significantly greater than the high-value cards; then, the MIT team knew it was time to act because the sequence of cards drawn built a story. And knowing how the story is unfolding is what gave them an edge.
And that’s what the 5% club is doing with the behaviour patterns. They are noting where the patterns occur within the schematic and they’re building up a story built from the emotional signatures left behind in time.
State Zero = Accumulation
In the Puppet on a String series, we discussed the process of accumulation. Accumulation is where the 5% club build their positions for the next trend move. Typically, after a down move and emotion bar sequence, the 5% expect the market to at least pause or stop going down; then, rally and then trade sideways.
The 5% club expect the lows of the emotion bar to be tested. They mark the buying tail of the emotion bar as the probable testing zone.
During the testing phases, the 5%, establish their long-term positions.
The 5% club know, when they see an emotion bar of frenzied behaviour after a vicious move down, the market should pause.
If you assign heads in a coin toss to a win and tails to a loss, then, if you toss a fair coin, what is the probability of heads? It’s 50%. But what is the probability of getting five heads out of five coin tosses?
It is: .5 x .5 x .5 x .5 x .5 = 0.03125 or 3.125%
Instead of five coin tosses, what if you witness a sequence of five moves. What if following an emotion bar you see four moves in a sequence. Each move is like a single coin toss event and doesn’t tell you much, but by combining the emotion bar and the following four events into a sequence, you can begin to build a probability of this happening, given you have an emotion bar.
Markets aren’t mechanical, and rarely work as clearly as the idealised schematic, but they are a framework through which the 5% club can assess the risk of a position.
If the 5% see this sequence of moves: Emotion bar, automatic rally, 1st secondary test, 2nd secondary test, high volume breakout of range; then, the odds are in their favour that the market will transition out of a stage zero accumulation phase and into a new uptrend. Again, this does not give you any guarantee that it will. It’s a probability and not a certainty.
If the breakout is successful, then a new trend will be born.
During the trend, the 5% club will be taking profits from positions built up during the accumulation phase. The 95%, will be on Twitter and reading the Gurusphere, hoping their chosen icon will confirm what to do.
The 95% rarely act with conviction and are most often late to the party. They chase positions and enter will no clear points of reference for risk management. Contrast this to the 5%, who have clinically taken positions during tests of the emotion bar lows.
Markets move into new uptrends when demand overwhelms supply. It’s how prices can move through time with, sometimes, minimal volume. Eventually, the media starts reporting the move, the Gurusphere goes into overdrive, and the 95% get aboard.
Until it ends.
State Two = Distribution
Uptrends tend to end with emotion bars too. The only difference is that sometimes the close of the bar is also near the high of the day.
It’s a signal the 95% have gone all in.
As the market moves up, the 5% is slowly selling their positions to the 95%. The 5% club, the strong hands, who owned the market during the lows of the accumulation phase, have now sold out. In their place are the weak hands, the 95%. The 95% enter out of position, have non-existent position size and money management, and they typically are clueless about the price cycle.
The signature of the 95% going all in is an emotion bar with a wide range and a high volume turnover. Just like the end of a downtrend, after a high volume up move, the 5% expect the market to react down and then test the highs of the move.
This phase is called distribution. It’s where the strong hands offload any remaining long positions to the 95%.
If the 5% see this sequence of moves: Emotion bar, an automatic reaction, 1st secondary test, 2nd secondary test, high volume breakdown of range; then, the odds are in their favour that the market will transition out of a stage two distribution phase and into a new downtrend.
And the cycle beings again.
Speculating within this framework allows the 5% club to understand the expectation of the next sequence of moves. It enables them to build positions in high probability locations, and this gives them the ability to control their risk.
Take the time to view any cryptocurrency market and notice the next sequence of moves after an emotion bar. Emotion bars show up across multiple times frames too. Take a look at daily, 240 minute, and 60-minute charts and observe what happens after you see an emotion bar.
Using a simple idealised schematic and behaviour patterns left behind on a chart, the 5% club, the consistently profitable, are quietly reading your hand.