Price, Time Period, Volume, and the 4th Dimension of Every Crypto Market!
The 4th Dimension
“Remembering that you are going to die is the best way I know to avoid the trap of thinking you have something to lose. You are already naked. There is no reason not to follow your heart.”
10 Metre Board
Control. It’s an emotive word. Most people assume they can control the situations they find themselves in.
But few can walk the walk when money is on the line. The main contributor to not having the life you want is fear. Fear of failure is obvious. But what about fear of success? A lot of people, more than you realise, blow up because they feel they don’t deserve the reward.
Most play the game safely within the boundaries they set while growing up. They come up with excuses for why they made one choice over another. It’s an ego thing — the voice in your head keeping you on the safe side of the fence.
You circulate the board of life, collecting $200 for passing Go. The reasons for the choices you make become set in stone. And then you try trading and investing. How hard can it be?
Some people can make quick decisions. Most can’t. Some, trust themselves. Most don’t. Most engage in constant chatter with themselves. Should you, shouldn’t you. They call friends. They search for opinions that are congruent with theirs.
In life, you can get away with this behaviour for the most part. But in trading and investing your default behaviour patterns are not so useful.
It’s a long and lonely climb to the 10-metre diving platform. From the pool it doesn’t look too bad, but as you climb things start to look a little different. And so it is with trading.
The problem is most take the leap before they’re ready. A successful trade is like a successful dive. There’s an envelope for success. A little too much one way, and you’ll overbalance resulting in a nasty head over heels splat as you hit the water. A little too much the other, and you’ll be entertaining the other swimmers with a shorts removing belly flop.
Most use too much money when they first start. And worse, they use too much money betting on someone else’s idea. A lot of people come to trading as a solution to a problem. Perhaps it’s a way to become self-sufficient. A way to be able to quit your job and live the life you want.
Ten metres up and standing on the edge of the platform are you ready to jump? And as Steve Jobs said, you’ve got nothing to lose — except maybe your shorts.
What’s The Count
The cryptocurrency market has the potential to give you the freedom you want, but like any other market, it can do the opposite too. It starts by coming up with an idea and trusting it.
Last week we talked about how you can put a number on your idea. Exactly like the MIT blackjack team who counted cards to give them market feedback on when the game changed in their favour. You can use Plus-One days, days that signal the 95% panicking out of a position and the 5% club (the consistently profitable) stepping in and buying, in the same way.
Using a technique based on Benjamin Franklin’s moral algebra for working with imperfect information, you asked questions of a market, in this case, Bitcoin, and assigned a value of one or zero to the answers. This gave you a probability of success.
Then you plugged the numbers into the tool the 5% club use to establish the likelihood of the idea being profitable over time.
That tool is Expectancy. And the formula is…
(%WIN x AvgWIN) - (%LOSS x AvgLOSS)
Next, you calculated your initial risk and used 1.5 times the average daily range. The daily range was $708, and this gave you a rounded figure of $1,000 risk. The answers to your three questions were all tails, and you asked what the probability was of getting three tails in a row.
It’s 12.5%. (.5 x .5 x .5)
And plugging the numbers into expectancy gives…
(12.5% x AvgWIN) - (87.5% x 1,000)
AvgWin = ((.875 x 1,000) / .125) = $7,000
Bitcoin would have to move $7,000 just to break even.
(12.5% x 7,000) - (87.5% x 1,000) = Zero (breakeven)
This is not a great bet.
Remember, you are on the lookout for non-random days. You’re waiting for the market conditions, just like the MIT count, to be in your favour.
Putting a number on your analysis enables you to quantify the risk. Rather than listen to someone else, you can use your own insight and put a number on it.
Would you rather trade because someone else told you it’s a buy? Or would you rather know the position has a one in eight chance of success?
The 5% who are consistent don’t take tips from others. They do the work. They figure out the likelihood of success, and one of the tools they use is expectancy.
The 5% use their own version of the MIT count. If you start trading in cryptocurrencies and you don’t know what your count is, especially if you don’t have a way to trust your own work, generating consistent returns will be difficult.
And if you’re taking positions with real money, it’s easy when the market you’re trading is the hottest game in town. Keeping your profits when it’s not— that’s another story.
Because the 95% trade with their emotions. And this is something you can use.
Who’s trapped? It’s chief among the conditions you are looking for because it’s a sign of FEAR or the lack of it.
Success in speculation and investing is being able to ask the right questions — and trusting the answers.
If you own a cryptocurrency and the price is going down what are you going to do?
When facing losses, the 95% will start checking the price every couple of hours, maybe even more frequently. The size of the position is proportional to the frequency of price lookups. They’ll start searching online for anyone with an opinion. They’re looking for someone to tell them it’s ok. They’re looking for confirmation, so they don’t have to take a loss. Anything to avoid the pain.
Meanwhile. Tick tock. The prices keep going down.
Everything has been stripped away, they’re naked. Someone or some system told them to buy. They thought of the rewards and little about the risk. Now alone, and facing losses, they hit the exit button.
This is called being out of position. The 5% club know that it’s not the results you focus on. It’s the process.
Keeping yourself on the “right” side of the market isn’t about always trying to win. It’s about executing a trading idea perfectly. The 5% club know if you can do that the profits will look after themselves.
And flawlessly executing a trading idea starts with understanding not only yourself but how the majority of traders behave.
If you’re facing losses and the market is screaming against you, ask yourself —
Who buys here? Who sells here?
Did you figure out a strategy? A strategy that includes, entry conditions and exit conditions (for losses or profits)
Why did you enter the position?
Did you chase the trade, because you were late to the party and you just had to get in?
How long did you expect to be in the trade?
What was your expected timeframe?
Am I acting with the crowd?
If you enter here, are you part of the crowd? In other words — is it obvious? Is it all over the news and social media? Is it a no-brainer?
How long has the deal been on offer? If this is such a fantastic opportunity, why has it been available to you at such great prices for so long?
Most important of all, ask this…
Is anyone trapped?
Did you enter at a price where, if it goes in your favour, traders on the other side of the market with the opposite opinion to you are going to be wrong, and they’re going to have to get out? And get out now?
Ideally, if you buy, because you expect the market to go up, there will be many others who are betting the market will go down, around the price you entered.
If you can enter, and go long, at the time when the majority are speculating the price is going down and the price rallies, they will have to take action. The pain of loss will be too high. If they are short, they’ll have to buy to get out.
Let’s say that a market closes at 100, and the next day the market opens at 90. Is anyone trapped? This isn’t enough information to make a decision. The next day the market closes at 80. Is anyone caught? The answer is no, because anyone who bet the market was going down is right (so far), and they won’t be in a hurry to get out.
The next day, the market opens at 105, and you notice the volume of turnover yesterday was 300% above average.
Is anyone trapped today? Yes, they are. The increase in turnover is a clue that more people have got aggressively short the market. But, more importantly, if you ask yourself at this point if the people short were late to the party — were they the 5% club? Probably not, because you know the 5% club don’t chase positions. They got in when the market was at 100, and they were exiting their positions when the price dropped down to 80.
The majority of traders don’t have a plan, and they’ve been sucked into a short position. At 105, the market has reversed trapping them into a losing trade.
And the only way out is for them to buy. And it’s their buy orders that help propel your buy order into profit.
It’s like having the wind at your back.
Is anyone trapped, and do they have to get out? Like the story of the crowd at a concert, (Thinking In Threes) if they have to get out, they have to get out fast. This translates into a fast move in the opposite direction — the move you are positioned in. And the quicker you can get your position to no-risk, the more consistent your trading results will be.
The 4th Dimension
The first two dimensions of trading, investing, and speculation is the market price and the time period. These mark out the X and Y axis on a chart. The third dimension is volume, the turnover over of trade.
Now it’s time to think like Leonardo. Not Leonardo DiCaprio. Leonardo Da Vinci.
A market can move up and down and is measured on the X and Y axis of a chart. Have you ever considered if a market can move in and out?
What if a market not only moved up and down but also moved in and out?
It can, and it does. And what makes this happen is the 4th dimension. Think of it as the market breathing.
Most have not heard of the 4th dimension. The 95% have little or no clue of its existence. But exist it does.
The 5% club know how to use it, and after you’ve finished this article, you will too.
The fuel of the 4th dimension is fear. Imagine how useful it would be if you could measure fear, better yet, imagine if you could bottle it. Because if you could, that would mean you could compare how much fear existed at specific moments in time. Like the MIT’s mental card counting, you could use it figure out your “count.” You could use it as a gauge of when the market becomes less random, or when the market odds swing in your favour.
Fear, the 4th dimension, is measured using implied volatility. The degree to how much a market cares about the level of IV is measured by the market's sensitivity to it at a given point in time. The sensitivity of a market to its IV is called VEGA.
It’s derived from this.
But don’t worry. There’s a non-math way to use it.
Would you buy this?
It goes against all the things a new trader is taught. You’re taught to trade with the trend, and always use a stop. No way you’d buy this.
But someone does.
The question is who?
The reason you don’t buy it is that you are thinking about how you make a profit, or in this case, a huge loss, if you are stupid enough to buy it. Yet some traders are stupid enough.
Have you ever asked yourself why?
Most traders think about making a profit using positional difference as a measure of success. You buy at 50, and you sell at 100. But this is not the only way to trade.
Liquid financial markets have derivative products called options. We’ll be talking about options in the future, but right now, it’s enough to know why they exist, and how the 5% club use them.
The futures and options markets weren’t invented for your benefit. They were created so producers of commodities could control the volatility of their profits, and allow companies to attract new investment by being able to smooth out returns and give more accurate financial forecasts.
Using options, you can speculate on the market going up and on the market going down.
Remember, the first two dimensions, price and time, tracks price change over time and is seen on an X and Y axis of a chart. The third dimension is volume, and it’s a clue to the intensity of the price action. The 4th dimension that influences price is implied volatility.
Implied volatility measures how much an asset is expected to move in the future.
The most well known implied volatility measurement is the VIX.
The VIX measures the amount of future volatility expected in the SP500 stock index in the next thirty days. It’s also known by another name. The FEAR index.
Here’s how most traders use the VIX. (This is not the 95%. Most of them don’t even know what the VIX is.)
When the VIX is quiet, under 15, no one is worried about the future, and this is a signal the market is complacent, but when the only way is up — the only way is down. As the VIX reaches extreme lows, it’s an advanced warning that the market state will change from low volatility to high volatility.
And conversely, when the VIX spikes up, traders and investors are worried about the future. And when the only way is down — the only way is up.
The simple way to use the VIX is to notice the rate of change visually.
When markets go down, the VIX is expected to rise, remember it’s a sign of fear entering the market.
Spikes up in the VIX are signals that traders are prepared to pay more for the options. (For now, think of options as tools used to insure positions) And the more expensive the options become, it’s a sign that more and more traders are becoming trapped, just like the concert goers we talked about in the Thinking in Threes article.
A high reading in the VIX is direct market feedback that traders have piled in. If the market does not do what they expect, prices will snapback like a tango beat. It’s a signal a group of traders are caught on the wrong side of the market.
There’s another way to use the VIX — strictly reversed for use by the 5% club.
It works like this…
The VIX is an inverted index. When you see spikes up, like the one at 50 in 2018, it’s the market giving you direct feedback that prices in the future will be much more volatile.
Divide the value of the VIX by 12, and you’ll arrive at the percentage future movement the market is pricing in for the next 30 days.
The VIX at 20 is the market giving you direct feedback prices in the SP500 are expected to move 20/12 percent, or 1.66% up or down in the next 30 days. When the VIX is at 50, the SP500 is expected to move 4.16% up or down.
The 5% club use fear, as measured by implied volatility, to estimate the desperation of the crowd. When do the 5% take action? When the 95%’s eyeballs start to bulge.
Why learn about using fear, if you can’t measure it in the cryptocurrency market? Bitcoin, Ethereum et al. — there’s no VIX for them.
But what if there was a way to approximate the level of fear in the cryptocurrency market? What if there was a way you could mimic the fear?
Bitcoin Fear Index
The blue line is the real VIX on the SP500.
The multi-coloured line is the fear index used with Bitcoin.
This is a way to mimic the VIX volatility index, and it works on all cryptocurrencies.
It means you can gauge the level of fear in any cryptocurrency market, and on any time frame. From 1 minute to monthly.
When you see volume turnover over 300% of normal, and when you see the cryptocurrency price have a wide range day with a close back at around 50% of the overall range, you’ll be thinking in threes. You’ve just noticed an emotion bar. It’s a Plus-One day.
You’ll have three good reasons the market has just entered a non-random state, and just like the MIT blackjack team now is the time to take action.
You may be a trader who only expects to be in a position for a few days, and in this case, you could you this non-random state for entry, or you might be a long-term trader, and if so, you can mark this day using the buying tail as a testing zone.
Plus-One days are useful because you can use them to build a narrative about price action. They are a powerful indicator of the current state of the market, and they don’t lag, like moving averages, instead, they provide feedback on the emotional state of the market participants in real time.
And if you see a Plus-One day, how can you use the fear index to help you figure out the likelihood of your position being successful?
The Bitcoin Fear Index estimates the level of fear. If you’re about to sell, as Bitcoin prices fall, but the Bitcoin Fear Index is red, think about who’s on the other side of the trade if you sell? Think about who’s buying.
You can use it as a “heads-up” if you’re chasing a trade too. If you are looking to get short Bitcoin then ideally you’d be in position when the index is amber. If you get short when it’s red, you’re chasing.
Back in the day, traders used all sorts of techniques while attempting to gauge the level of panic in a market.
And one old-school technique was a squawk box subscription. A squawk box is a microphone recording the trading activity in the pit. It was simple to use.
When the level of activity went from quiet to chaos, traders used the noise to front-run market moves, and when the levels of noise, shouting and chaos reached a peak, traders attempted to fade or bet on a move in the opposite direction.
If there was pit trading in Bitcoin, what do you think the level of noise would sound like when prices hit $5,920 on the 6th February?
Orderly conduct? No. The opposite.
Buying Bitcoin on February 6th or 7th goes against everything the 95% are taught. But someone bought it.
The 4th dimension is fear, and if you could measure it, you can gauge the panic level in the market.
If you could gauge the level of fear, not in decibels, but in how much price movement Bitcoin is likely to move in the future, it would give you a way to measure the fear.
And if the level of fear is at an extreme, just like the screams and shrieks from an old-school squawk box, it means that traders are trapped — if prices reverse.
When the only is down — the only way is up.
Fear is measured in implied volatility. But the problem is, how do you find out the IV of Bitcoin?
Implied volatility is found in an option chain, and the IV value from this option chain is 75.4%. Once you have the value, you can use a back-of-the-envelope calculation to arrive at the number of dollars risk that’s being factored in by the level of fear.
The formula is
Bitcoin Price x IV% x SqRoot(Number of Days to Expiry)
The SqRoot of 365 (Number of Bitcoin trading days a year)
Plugging in the numbers for the 6th Feb low,
($5,920 x 3.32 x 4.80) / 19.1
you arrive at +/- $4,939
This means at the 6th February low, the fear level of Bitcoin was pricing in a move of +/- $4,939.
You may be thinking this is not usable because the price could move up or down. But it is.
Trading probabilities are driven by implied volatility. IV is driven by prices, and prices are driven by supply and demand.
At the low of $5,920, the level of fear was so great, the downside price movement was calculated at minus $4,939. And $5,920 minus $4,939 is $981. A fall of 83.4% from the 6th February low. It's a signal the 95% are getting out at any price.
The 95% buy (go long) options. But who do you think sells (go short) the options to them? The answer is the 5% club.
The 95% assumes the only way to make money speculating is by taking a directional trade. They think it’s all about buying at 50 and selling at 100.
A large percentage of the option price is from the increased levels of fear, or implied volatility. The 5% club use strategies that sell this volatility to the 95%.
It gets even better for the 5% club. They don’t have to wait until the option expires to be free of the obligation. All the market has to do is go up for a few days, and the levels of fear will subside. As the levels of fear go down, the implied volatility goes down, and the price of the option drops. This phenomenon is called a "Volatility Crush," and it gives the 5% club an opportunity to get out of their position for a significant profit.
At this stage, you might be thinking the 5% club never lose. They do. Nothing is 100%.
But if they lose, they know it’s direct market feedback, and they know what is most likely to happen next.
If you take a seat at the table with a tip from YouTube, and you don’t know what you’re doing, the 5% club will be waiting for you.
A powerful tool in their arsenal is the 4th dimension. The 4th dimension is fear, and the good news is there’s a way to measure it.