Speculation in cryptocurrency markets is difficult because the lesson comes after the test
Title: MACHINE GUN PREACHER
“Courage is grace under pressure.”
— Ernest Hemmingway
Bloomberg TV — Monday 24th September 2018: November Crude Oil futures, trading on NYMEX, open and move to a new high on 633% of average volume.
“How high do you think Crude will go?” asks the perplexed Bloomberg anchor.
His regular co-host looks at him, her eyes rolling, giving away her disdain, “Do you think I’d be sitting here doing this if I could call the oil market.”
Trading and investing in financial markets seem so easy. The market can only do one of two things. It can go up, or it can go down. So why do so many people lose?
Has this ever happened to you?
Something new catches your attention, so you check out who’s behind it and what’s going on. One day you notice the price of the company behind the idea has started to go up.
That night, while googling for holidays and the IWC watch you’ve always wanted, you begin to think about what to do with the profits if you bought into the idea. You’re excited, but before taking action you do your due diligence, and after a bit of research on social media you realise a lot of others feel the same way as you.
Decision made. You fund your account and hit the buy button. At first, you're happy, and the world is a good place. But fast forward a few weeks, and you’re not feeling so great.
The price is down, and you’re losing money. Again, you hit social media, and after spending a few hours on google and twitter, your mind is at ease. A celebrity guru is telling the audience about the opportunity of a lifetime and presupposing that instead of selling, you should buy more. And, because buying more at a lower price lowers your breakeven point, you buy.
The market starts going up, but you’re not feeling confident. The unexpected loss unhinged you, and you begin to check the prices a couple of times a day. The voice in your head is tempting you to sell, whispering, “If you get out now, you have a profit.”
But you don’t because losing money hurts, and the price should go back up. The guru said so.
A week goes by, and you’re seriously underwater. You notice the most recent low, a place where a month ago the market rallied. “If the price goes down to that low, I’ll get out,” you say to yourself.
Three days later and your investment is trading down at the low. You can’t believe it, but still, you do nothing. The loss isn’t real until you take it. Right? Wrong.
After another round of twittering and googling, you feel a bit better. “This is just a temporary move,” the voice in your head giving you comfort because the Gurusphere is full of chatter on why it’s happened.
You decide, no matter what, to get out tomorrow.
Next day it’s up, and you’re pleased with yourself for staying the course. And it’s up next day too. Finally, you relax, thoughts of getting back to breakeven in your head.
The first thing the next day you check again, and you can’t believe it. Your investment has had a dreadful night. It’s at new lows, and you’ve had enough.
Disgusted, angry, and ashamed you sell. You’ve lost nearly 60% of your money. Over the next few months, you gradually forget about it. But one day, something catches your eye. It’s a new way of…
And so, it begins again. Around and around. It's how the majority experiences trading, speculating and investing. It’s a non-stop emotional roller-coaster from beginning to end.
If you bought into Bitcoin at over $10,000, then you might be familiar with how this feels. Bitcoin, this time last year, was a hot market. In early fall 2018, after losing 70% of its value, Bitcoin is in the doldrums. The new hottest game in town is cannabis stocks. Tilray, ticker symbol TLRY, is a company that exports medical marijuana to the United States for trials.
Why are we discussing a US company stock and what has this got to do with cryptocurrencies? Human behaviour shows up in all markets, and leaves behind footprints the 5% club, the consistently successful speculators and investors, look out for.
In the Deus-Ex series, we discussed why frenzies don’t begin trends but end them.
Tilray’s price action in August and September 2018 is a great lesson of what a frenzy looks like.
Tilray has gone up 1,263% since July. The recent market high prices the value of the company at nearly $28 billion. There’s only one little problem. Tilray only has sales of $28 million. As discussed in Close Quarter, this values Tilray at 1,000 times sales, and this means, if you were a billionaire and purchased the entire company, it will take 1,000 years to get your seed investment money back. An outrageous overvaluation.
The 5% club took positions between the 15th and the 20th of August. After that, it’s pure speculation.
There are only 21 million shares of Tilray available to trade. On the 19th of September 2018, 19 of the 21 million available shares changed hands. It's a signal that the strong hands, the 5%, passed on the inventory to the weak hands, the 95%. Prices dropped 67.7% in four days.
Onboard an emotional roller coaster trying to be right, with no plan, no risk, and no money management, the 95% are destined to fail.
The 5% are patient. They wait for catalysts to force them into a position. The 95% think about the price they pay, but the 5% don’t. Instead, they watch out for new information that adjusts the potential future value of the market they are interested in trading.
The 5% wait for triggers; they wait for catalysts that change the dynamic between supply and demand and events that change perceived future value. Sometimes the trigger is an exogenous natural disaster like the 1906 earthquake in San Francisco. Sometimes it’s because of human behaviour like the forced selling of stocks purchased on margin credit in 1929.
Triggers can be external shocks that cause fast moves, or they can be more subtle endogenously generated changes.
What motivates change?
How did we get from this in 1903
In 63 years.
Let’s compare the technology.
Wright Flyer - Kitty Hawk 1903.
Max Speed: 29.8 MPH
Max Altitude: 30 Feet
Range: 200 feet. (Flight time of 12 seconds)
SR71 Blackbird - USAF 1966.
Max Speed: 2199.65 MPH
Max Altitude: 85,000 Feet
Range: (Unlimited due to airborne refuelling)
”The organising principle of any society is for war. The basic authority of a modern state over its people resides in its war powers.”
— Report from Iron Mountain
The catalyst for leaps in human achievement is war. It’s how we got from the Wright flyer at Kitty Hawk in 1903 to the SR-71 in 1966.
It’s not too difficult to figure out the advances in aircraft design and performance is a direct consequence of war.
But what about the not so obvious leaps in technological development that have occurred because of conflict and war?
What was the catalyst for the motivation to connect computers in a way that could send and receive data via multiple paths at the same time in the late 1950’s? A method to transmit data between two points, even if parts of the network were offline or destroyed.
Sputnik. In the event of a nuclear war with the Soviet Union, the US was motivated to find a way to be able to communicate if the US was attacked.
The solution the United States came up with to safeguard against communications failure during an enemy attack is called a packet-switched network. It was the birth of what would become the Internet.
When was the first computer invented?
During WWII, the British, using the genius of Alan Turing, were motivated to crack the German Enigma code so that they could intercept German U-boat signals. The Germans used coordinated submarine “Wolfpack” attacks to sink British merchant shipping.
The British were motivated to crack German communications because they could not sustain the losses the U-boats were inflicting. They needed supplies to get through, or they’d lose the war.
Turing created the “Bombe,” the blueprint for the computer on your desk, to crack the Enigma code.
After all this, you might be thinking the first computer was designed around the 1940’s.
But you’d be wrong.
The answer is 1822. Yes, that’s 18.
In 1819 Charles Babbage was motivated to build a machine, the world’s first computer to calculate tables for the British Government.
What kind of tables?
The kind where you look up logs so you can point your guns at your enemy more quickly and more accurately.
Sponsored competition is also used to motivate innovation and new ideas. In 1919, Alcock and Brown flew non-stop across the Atlantic for the first time, replacing the bomb doors of their Vickers aircraft with petrol tanks.
The Schneider Trophy air race was held between 1913 and 1931. Its purpose was to develop innovations in airplane technology. The star of the show was the Supermarine S6.
You know the S6 by its other name: Spitfire.
Remove the floats and replace with a retractable undercarriage and what do have? The best single-seat fighter of the Second World War.
The motivation for the growth and continued development of new technology is war. Change can come quickly and have a shock factor, but most of the time change is subtle and slow moving. The 5% club know that market participants take time to price in new information.
Modern warfare is not only fought with bullets on the battlefield. In 2018 there’s a new, covert, and equally deadly theatre of war. We’re no longer fighting hand to hand, huddled in trenches. Today the war is taking place in the integrated circuitry of computer networks.
Over the last two decades, the public has been sharing their information online. New corporate giants have been built on this precious commodity. A commodity the public has given away for free. Few realise that uploading and sharing data is no different than being pacified with public games by the Caesars of Ancient Rome.
Only now, after the brave new world has been built, are the masses starting to look around and realise what they’ve done.
Their data can be used against them. Brexit and the 2016 US Presidential election results are alleged to have been manipulated by using these datasets. Government policy is rarely proactive. It’s reactive. That’s why legislation gets passed into law after the fact. It’s why new rules come into play after a stock market crash and not before — after the people the new rules are brought in to protect have lost their fortunes.
The public has become the cannon fodder of the 21st century. They’ve been used, and the politicians and the media are ramping up the rhetoric against the power of the big tech giants and their centralised control of data.
The governmental solution will be sold to the public as a benefit — as a way to keep them safe. But it’s not about the public’s safety; it’s about national security. It’s about protecting the flow of money across borders, and it’s about protecting the economy.
Could this situation act as a significant catalyst to release hidden value in cryptocurrencies?
And if so, which coins or tokens are more likely to benefit?
In the Games without Frontiers series, we discussed the new environment of distrust building up between nations.
The 5%, using thought tools like the trilemma, monitor changes that will affect the future value of an investment class. There’s a clear global shift towards nationalism and protectionism. In this environment, the data held could be used as a weapon against a country. Financial markets, central banking, banks, power grids, air traffic, supply chains, and even democracy itself are dependent on data security. It's why governments are rushing to protect data, and why there is a high probability the next five years will become the perfect incubator of new blockchain powered systems.
In this environment of distrust, a new technology using blockchains is more likely to be adopted. It’s a slow moving and subtle trigger, and if the assumption is correct, the value of blockchain related products will increase. New demand is created as more and more people become aware of the undervaluation. Eventually, the supply in the market is absorbed, and prices go up.
The catalyst for repricing an asset might be slow and subtle, or it may be a sudden shock.
The 5% use tools like trilemmas to estimate the impact of new geopolitical relationships and other barriers to free trade. They understand markets are more likely to price in changes slowly and that it takes time to revalue an asset fully. The 5% club operate during the gap between initial discovery and full market awareness. They buy when markets are of little interest and sell into frenzies.
This process is the cause of the four-stage price cycle we discussed in Deus Ex. In September 2018, Bitcoin is in a sideways move, but is Bitcoin in an accumulation phase or is it being distributed before trading much lower?
The 5% club have a long-term view on the future value of Bitcoin, but are they accumulating positions and buying at wholesale prices, or are they distributing their holdings because they expect a collapse in prices?
In the Thinking in Threes series, we discussed how the majority of traders ask questions about the market they are interested in trading. They use technical moving average based indicators to give them the answers. The problem is, the 95% don’t realise how the tools they’re using work. They don’t realise that indicators like MACD, RSI, and stochastics are all attempting to tell them the same thing. The only question these indicators can answer is if the price is diverging from momentum.
And they can all be replaced by using a simple momentum line drawn under the two previous lows for a low, and over the two previous highs for a high.
After they have an inevitable string of losses, the 95% start to fiddle with the indicator settings. They back-fit the indicator settings that produced the best results in the past, and they stack indicator after indicator onto a chart expecting to find the magic setting to unlock the success they’re so desperate to achieve.
The majority of traders, the 95%, fail because when they’re under pressure after a string of losses, they either panic and give up or go in search of another system. They do this until they’ve wiped out most of their trading account. Eventually, they’re replaced by a new batch of traders with a new stash of capital looking to change their lives.
And around it goes, with the 5% keeping the 95%’s capital. Thanks for coming. Next.
Consistency, over both the long and short term, comes from understanding the interplay between supply and demand, and not from the settings used by an indicator.
Bitcoin is in a sideways move. Moving average based indicators like MACD don’t work well in non-trending markets. The signals will chop a trading account to pieces.
One solution the 95% use is to change the way the candlestick price bars are calculated. Techniques like Renko, Kagi, and Heikin-Ashi visually reduce the noise of the up/down movement of each price bar.
This is a standard candlestick chart of Bitcoin.
And this is a Heikin-Ashi chart of the same data.
Heikin-Ashi seems like the perfect solution, but look underneath the hood and guess what? — you’ll find Heikin-Ashi is just another moving average system.
Heikin-Ashi uses four inputs, a combination of data from the most current bar and the previous bar.
If you take a look at how HA bars are calculated you might think they don’t lag like standard moving averages because they only use data from today and yesterday.
It’s an illusion.
If you plot a weighted five day simple moving average of the close and an exponential five day moving average of the open on a chart, you see what Heikin-Ashi is.
Here’s the code.
wClose = ((close5) + (close14) + (close23) + (close32) + close4) / 15
wOpen = ema(open,5)
Heikin-Ashi is just another moving average system. Make two moving averages using the code above and overlay them on a standard chart. Then compare the moving average crossovers to a Heikin-Ashi chart.
When you are trading using HA charts, you’re just using a 5-day weighted simple moving average of the close and 5-day exponential moving average of the open as a dual moving average crossover system.
What you’re not doing is analysing supply and demand.
Often, when the 95% first use HA charts, they think they’ve found their perfect indicator.
Here’s Bitcoin in recent sideways price action.
And here’s the HA version.
Look at how well Heikin-Ashi bars remove the green and red up and down noise, replacing them with longer sequences of green and red. The rules of using HA are simple. Here’s one way to use them. When the HA bar changes from red to green, then buy on a break of the green bar high. When the green bars change to red, sell on a break of the red bar low.
The majority of traders who use HA charts, don’t realise they are using a moving average crossover system. HA is the same as buying when the 5-day weighted moving average of the close crosses over the 5-day exponential moving average of the open.
The selling point of HA charts is that they reduce the noise, and keep you in a position for longer. They are designed to help you avoid being shaken out of a position. But that’s what the dual moving average system does. When the 5-day weighted moving average of the close is above the 5-day exponential moving average of the open, stay long.
Same system. Different dress.
A moving average system can be expected to trigger a lot of losing signals in a sideways market. It doesn’t matter if the moving average system uses long-term moving averages or short-term moving averages, or a combination of both, you can expect to experience a lot of losing trades.
The main difference between the 5% and the 95% is the 5% understand the nuances of the tool they’re using for entries, exits, and risk management. The 5% understand the strengths and weaknesses, but the 95% don’t.
The 95% majority using moving averages, MACD, or alternate candle systems like Heikin-Ashi, jump ship and quit because they suffer a string of losses and think the system is broken.
The 5% understand how the system they’re using works because they take the time to look under the hood.
The 95% don’t ask the right questions. They don’t think to ask about the cause of protracted low volatility price moves.
Instead of asking if prices are being accumulated for a high probability up move, or distributed before a high probability down move, the 95% try and trade the same way as they always do without taking into account the context of the current market conditions.
When the 95% reach their maximum pressure point, and they can’t take it anymore, the move the 95% have been so desperate to be part of begins without them. It’s a cruel irony.
The 95% focus on winning, so it’s natural they feel pressure when they’re not. The 5% club are consistent because they aren’t focused on winning. They focus on the expectancy of their system, as discussed in the Shapeshifter and Revolver series.
Signal and Noise
The 5% club don’t compare price to price. They compare the price to value. They evaluate conditions and attempt to find undiscovered value using tools like the trilemma discussed in Games without Frontiers.
If favourable long-term conditions not priced into the market are found, the 5% club use charts as triggers to enter into a position and start building a campaign.
The 5% use the price cycle of downtrend, accumulation, uptrend, and distribution to understand the big picture context of the market they are about to trade and invest in.
Like the MIT blackjack team discussed in previous articles, who counted cards to find windows in time where the odds transitioned in their favour, the 5% use emotion bars as transition points between phases within the price cycle.
They use tests of emotion bar lows after a down move to evaluate new demand and overhead supply, and they use tests of emotion bar highs after an up move to assess if new supply is likely to overwhelm demand.
Bitcoin is trading sideways and has tested the February 6th, 2018 low five times.
The 5% are waiting for a condition to confirm the sideways price action as accumulation.
In the Revolver and Escape Velocity series, we discussed how to put a number on risk. We asked given we’ve seen this evidence, what is the likelihood of an event happening.
We’ve seen an emotion bar and five tests. Each test recovered from the emotion bar lows without being overwhelmed by new supply, so what is the probability of Bitcoin being in an accumulation phase?
The 5% club know, by evaluating the evidence and building up a story, the probability is on their side. The confirmation signal they are waiting for is a wide range up candlestick breaking out above previous highs, a candle that closes near the high of the breakout day’s range on very high volume. Preferably over 300%.
This bar, if seen, will complete a sequence of events.
2. Emotion bar,
3. Tests (at least one), and
4. A wide range up bar on high volume, closing near the high.
You might be thinking the price cycle is of no use to you because you’re only interested in trading over the short term.
Even if you only day trade, knowing the probability of price location within the price cycle, is an edge because it allows you to use a point of reference to trade against. (This was discussed in the Event Horizon series.)
Having a point of reference allows you to maintain a high win/loss ratio. Not the amount of times you win, but how much you win when you’re right, against how much you lose when you’re wrong.
And this is where the 95% come unstuck. They don’t use the price cycle and they take the same trades all the time, regardless of context.
This chart takes a quantitative look at a Heikin-Ashi trading system.
Heikin-Ashi is a moving average based system. It fools the 95% because they don’t understand how the tools they’re using work. Visually HA charts look great because they remove the noise from a chart.
Most of the time, a candlestick or bar does not indicate whether the next bar or candle will be up or down. Most of the time bars are random like the throw of a dice.
The blue line in the chart above shows the rolling probability of the current bar predicting if the next bar will close up or down. Currently, it’s 49%.
The green line in the chart above shows the rolling probability of the next Heikin-Ashi bar. The green line is not computed from the ordinary bars in the chart; instead, it’s computed using Heikin-Ashi bars. Compare the 78% probability of the HA generated green line to the standard candlestick bar generated probability of 49%. This is what Heikin-Ashi is designed to do.
Currently, today’s HA bar is giving a 78% probability that tomorrow will be the same as today. If it’s green, then tomorrow will be green 78% of the time and vice versa. But to give you this information, Heiken-Ashi uses moving averages. And in sideways markets moving averages do not perform well.
Here’s another look at the quantitative view of the Bitcoin Heikin-Ashi chart.
The days where the orange line is equal to one represent the days where the HA chart successfully forecast the direction of the next day. If green, then the next day will be green. If red, then the next day will be red. The days where the orange line changes from one to zero are the days where the HA chart forecast is wrong.
Notice the periods from late July through mid-August and from the 20th of August until early September when the orange line is set to one. The orange line is Heikin-Ashi keeping you in the trade, just like the dual moving average system it is.
Think of it like this. A Heikin-Ashi candle is short-term dual moving average crossover system. Currently, it’s telling you that tomorrow, there’s a 78% probability the price will close above the moving averages.
But look at the string of losses in September highlighted with the red box. Using Heikin-Ashi in a low volatility market, like the condition Bitcoin is in now, is like getting a visit from a machine gun preacher.
Pop, pop, pop. Lose, lose, lose. The lesson comes after the test.
The 5% separate the signal from the noise; they know trading Heikin-Ashi candles in a low volatility environment is not an optimal strategy.
Locked and Loaded
The 5% can use Heikin-Ashi successfully. Because they know consistency comes from building a position around expectancy and not around how often you win.
It’s because they expect to lose a lot of the time if they use HA on a non-trending timeframe. (Like Bitcoin on a daily timeframe in September 2018)
Once you have a view on future value, you can lengthen your time horizon. If you believe society is moving towards an environment of less trust, and blockchains are more likely to be mass adopted because of it; then, you’ll own a long-term edge. Of course, you might be wrong. But if you use the price cycle to confirm your analysis, then you’ll be on your way to 5% club membership. You’ll know when a market is acting right, in line with your long-term views.
Finding value that isn’t priced into a market helps you hold your nerve when markets get volatile. It helps you build campaigns as prices move, and it helps you enter markets with a point of reference, which in turn helps you with position sizing and money management.
If the 5% club trade long-term, they have a long-term view and they use the charts to time their entry and position building. If the 5% only trade short term, they understand, as a minimum, the strengths and weaknesses of the tools they use. Long term or short term, the 5% know this: Investing and speculating is about reading supply and demand. The indicator settings don’t even matter. What matters is that you’re consistent.
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