Recognising a parabolic move in cryptocurrencies can provide traders with several advantages.
“Where are your Quotrons?”
“Yeah, your computers?”
“No, no, no, we don’t need computers here, we trade right off the Pink Sheets.”
— The Wolf of Wall Street
Monday, October the 19th 1987. A young, recently qualified stockbroker begins his first day at work. But this Monday is different.
This Monday etched itself into history as the Dow Jones Industrial Average recorded the largest daily stock market drop ever — down 22.6%, earning itself another name. Black Monday.
The young broker, on his first day at work, looked on in disbelief. Within a month, his company, L.F. Rothschild, had gone under leaving him out of a job.
Later, desperate for work, while cruising through the classified section of his local paper, he finds a job. Not for a stockbroker, but as a stock clerk for an appliance store. His wife picks up the paper, and, scanning through, she finds an opportunity.
It reads: A Career In The Stock Market
Walking into a run down office in Long Island, the young broker sits down with the office manager, who explains they don’t have or need computers because they trade off the Pink Sheets. Pink Sheets are an over the counter marketplace where stocks in companies too small to be listed on any of the major stock exchanges, like the NASDAQ, or the NYSE, can be traded.
The manager asks the young broker, what rate of commission he received when selling blue-chip stocks, smiling as he’s told the standard rate of commission is 1%, replying, with the Pink Sheets, it’s 50%.
Astounded, the young broker repeats the commission rate, “50%! 50% for what?” When he’s told it’s the markup for their services, the lights come on.
The young broker, wasting no time, gets on the phone, and makes a sale of $4,000 worth of stock, earning himself $2,000 commission, and, looking around, the office is silent, mesmerised in awe.
That young broker was Jordan Belfort, also known as the Wolf of Wall Street.
Belfort went on to industrialise the selling of penny stocks to the public through his company, Stratton Oakmont, eventually being convicted of securities fraud and money laundering.
So, what have Pink Sheets got to do with cryptocurrencies?
In the movie, The Wolf of Wall Street, Justin Belfort, played by Leonardo DiCaprio, gets on the phone and begins his pitch. He’s cold calling a customer, selling what his new manager has just told him is a hot stock.
The company, AeroTyne Industrials, is sold as an international up and comer, a cutting edge, high tech firm out of the mid-west.
As DiCaprio pitches to John, the hapless guy on the other end of the phone, the camera briefly shows the reality. AeroTyne is run from a single wooden garage.
“AeroTyne is awaiting imminent patent approval on the next generation of radar detectors that have both huge military and civilian applications.”
It sounds fantastic, but the audience knows, thanks to the camera shot of reality, it’s all made up.
Finally, with the story told, and the customer hooked, comes the close, explaining that, right now, the stock is trading for just ten cents over the counter, and our analysts are expecting this stock to go a lot higher. Your profit on a mere $6,000 investment will be upwards of $60,000. “That’s my mortgage,” the customer replies, and the pitch continues…
“In the case of AeroTyne, based on all of our analyst’s technical factors, we are looking at a Grand Slam home run.”
It’s all over. Seconds later, the customer is committing to buy 40,000 shares for $4,000. He’s purchased a stock trading at five cents for ten cents, and this means AeroTyne is going to have to go up 100% for him to break even.
The customer has been suckered into a junk stock at a massively inflated price. If he wanted to sell, he’d be lucky to receive three cents on the bid, or, said another way, the customer would get back $1,200 of his $4,000 investment, losing 70%. The only winner was the broker who’s just made $2,000 for two minutes work while also having zero risk.
If you are new to cryptocurrency, it’s easy to be overwhelmed when looking at the thousands of coins and tokens listed on sites like coinmarketcap.com.
If history is any guide, the majority of cryptocurrencies will not succeed just like stocks listed in the Pink Sheets. So, how do you find the coins and tokens with the best chance of making it? How do you avoid being suckered into a cryptocurrency equivalent of AeroTyne Industrial?
In the Wolf of Wall Street, the filmmaker showed the reality of AeroTyne, contrasted against the hype of the broker, by briefly displaying a screenshot of AeroTyne’s headquarters — a wooden garage somewhere in America.
But, it’s not as simple as finding out where the company is based.
Just a small apartment block in a then quiet and unremarkable Californian town. To the side of the main building, there is a single wooden garage.
Years ago, David Packard and his wife Lucille moved into this first-floor apartment, with David’s friend Bill sleeping in the single garage.
Not very impressive. But David Packard’s friend was Bill Hewlett, and their company Hewlett-Packard was started in that single garage. An unremarkable building, in an unremarkable town, but the address of the apartment block, 367 Addison Avenue, Palo Alto, California, is important because, thanks to Dave Packard and Bill Hewlett, it is the birth place of Silicon Valley.
You’ve got to work a little harder and dig deeper.
One of the big questions to ask when you’re researching cryptocurrencies is to ask who’s behind the company, what’s their background, and do they have a track record?
Finding out who the investors are provides useful information too, and if they’re funded by venture capitalists, go deeper with your research and analyse the current portfolio and track record of the fund.
Nothing is error free. All investing, especially cryptocurrency investing, involves an understanding of risk.
If you find yourself staring at thousands of cryptocurrency listings and begin to go “information blind,” overexposed to hype and promotion, drop back to the three basic questions
What real-world problem does this coin or token solve?
How does the underlying technology scale?
Who is backing the coin or token?
It’s how you avoid an over-hyped AeroTyne and find a Hewlett-Packard.
Sell Me This Pen
It’s all about supply and demand.
Staying with The Wolf of Wall Street, Jordan Belfort is sitting in a diner with his collection of misfit friends, and asks them if they want to get rich. One of the gang, Chester, boasts he can sell anything, so Belfort, reaching into his pocket, says, “Sell me this pen.”
One blank face and lame excuse later, Belfort gives the pen to Brad and asks again, “Sell me this pen.”
While most people wouldn’t know where to start, maybe describing how the pen looks, the weight, and the finish, mistakenly believing that it’s the features and benefits that sell, instinctively Brad does something else — he creates urgency by saying to Belfort, “Why don’t you write down your name on that paper?”
“I don’t have a pen,” Belfort replies.
Boom. Urgency created. Supply and demand.
Recognising the moments in time when supply and demand become unbalanced creates asymmetric trading opportunities, where risk can be quantified, and, even if the position fails, valuable information can be received about the most likely future direction of the trend.
In June 2019, Bitcoin went vertical, appreciating 86%, but, as discussed in the Parabolica series, parabolic trends have a tendency to end moves.
One of the skills used by the 5%, the most consistent and profitable speculators and investors, is the ability to recognise when a market has gone parabolic.
As a market trades higher, trend lines are drawn between the low and the first higher low; then, as subsequent lows are printed on the chart, a new trend line is drawn connecting the first higher low with the second, the second with the third, and so on, as the market moves through time. Once three trend lines have been defined, if each of the three lines has a progressively steeper slope, the likelihood is that the market is moving into a parabolic high.
Recognising the potential for a parabolic move gives the 5% several advantages. First, once a market goes vertical, the move does not usually last for long.
Using Bitcoin as an example, on the 21st June Bitcoin closed up 7%. As Bitcoin moved up $688, which was a 50% increase in the ten-day average true range, the 5% take notice of the context. Where is this move taking place in relation to the recent price action?
The recent price action is important because the highs and lows as printed on the chart are used to approximate the relationship between supply and demand.
Bitcoin closed up 7% in the shadow of three higher sloping trend lines, each with a higher rate of run or slope. This price action increases the likelihood of a vertical move higher, so with the increased probability of a fast vertical increase in price, the 5% estimate the sustainability or duration of the move.
At this rate of appreciation, using the daily compound interest formula, where the closing value is multiplied by one plus the rate of increase, in this case, 7%, and raised to the power of the number of likely days.
If Bitcoin increased in value by 7% over the next ten days, its price would double.
This, though not impossible, is very unlikely to happen, but recognising the increased likelihood of a fast move up allows the 5% the first advantage of being able to estimate the duration of the expected move.
The second advantage of recognising the price action of a parabolic move is that if the assumption is correct, the market, in this case, Bitcoin, will not break the low of the previous day for more than three days until the move is complete.
Beginning the count only when the low of the previous day is broken, ignoring inside days, where the high and low of the day are inside the high and low of the previous day, once the count begins, all days are counted.
It’s important to remember that markets are not mechanical. The 5% understand these are tendencies and not hard and fast rules, and the most likely tendencies have been observed by either backtesting, or empirical observations, or a combination of both.
Anticipating the expected price action gives the 5% their third advantage of direct market feedback. It allows them to judge when a market is not acting in line their assumptions.
For example, after three higher sloping trend lines have been observed, the 5% anticipate an acceleration in price. If this does not occur, it is direct market feedback that their assumption is not correct.
If the expected parabolic move starts, price will not usually close down more than three days against the trend, and this means, if price does close down two days in a row, it allows an additional entry location into the move with well-defined risk parameters, allowing the construction of a low risk to reward entry; but, if, after two down days, the market fails to recover, stopping out the additional entry, it is direct feedback the assumption of the move being a parabolic trend is most likely wrong.
Since the 4th of June low of $7,432, Bitcoin rallied for twenty-two days, only breaking the previous low for one day on the 6th of June, for two days on the 9th and 10th, and for one day on the 18th, during a $6,448 rally, making the price action consistent with the expected parabolic trend.
As a parabolic trend enters the final stages, the movement goes vertical, and vertical price action is often accompanied by bullish media attention.
During the move as Bitcoin surged over $13,000, the media attention matched the price action. “Bitcoin is back in a big way,” commented the Australian Financial Review.
In the Chain Reaction series, we talked about path dependency. Recent studies suggest financial markets, rather than being random and memoryless, are at certain times, less random and have a memory, following the new science of complexity theory.
Neil Johnson, a former Oxford University Professor, defines complex systems as the study of outcomes which emerge from a collection of interacting objects.
Observing three trend lines, each with a higher rate of slope, are tell-tale signatures that, a large percentage of the time, precede a parabolic move. As prices begin to accelerate, and, using daily compounding, the rate of change will have the effect of doubling the price within a week or two, ask yourself what is the likelihood of observing this phenomenological combination if your assumptions are false?
As prices move higher, noticing that each daily low is higher than the previous daily low, is an observation you can use to adjust the likelihood of your assumptions, but not only that, you can also use it to find low risk to high reward entries in a fast moving market.
What is the likelihood of observing three ascending trend lines each with a higher slope, combined with a rate of change, when compounded, that will double the price in less than two weeks, observing the previous day low is never broken as new highs are printed on the tape, if you assume you are not in a parabolic move, given that the three observed phenomena occur a high percentage of the time during parabolic trends?
Understanding likelihoods in a parabolic market also has a fourth advantage. By studying parabolic price trends, especially trends in the commodity markets, who have a tendency to produce more parabolic moves than the stock market, you’ll notice they have a tendency to end with a wide-range bar and increased volume.
By normalising the volume against a fifty bar average, you can clearly see the percentage increase, and observing a wide-range bar with around 300% of the average volume is a tell-tale sign the parabolic move is over.
On the 26th June 2019, Bitcoin printed a wide-range bar, closing well off of the high on 327% of average fifty-day volume, indicating the move is at an end.
When a parabolic move ends, the price will generally do one of two things, allowing the 5% a fifth advantage. It will collapse back to the origin of the move, trading aggressively down to the third or fourth ascending trend line, extended to the right, or the price will stay in a range holding near the top of the move.
Discussed in the Parabolica series, as prices break down from a parabolic high, it provides the 5% with excellent short term trading opportunities to the downside, selling the market short, or if prices hold near the highs, absorbing the recent move, it signals the continuation of the trend once the mean has caught up.
Remember, the observations are tendencies, not certainties. Trading and investing is not about being right or wrong. It’s about finding low risk, high reward entries, and managing risk.