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The internet, comment and quote brigade have noticed Litecoin!

DARK POOLS

“The soldier's spirit is keenest in the morning; by noon it has dulled; by evening they begin to think of home. The skillful warrior avoids the keen, and attacks the dull and the homesick.”

— Sun Tzu

Like hopeful warriors in the early morning mist, the autumn of 2017 exposed the public’s keenness for cryptocurrencies. They wanted in — at any cost. In January 2019, the keenness is gone. All but the most loyal have deserted the ranks. Of those who remain, the vast majority are looking for the first signs of dawn in the black of night.

Read on…


Neurotransmitter

In Choke Point, we talked about how buying and selling are dispersed throughout the cryptocurrency market, with around 85% of the exchange volume taking place in the top ten coins.

Recently the internet comment and quote brigade have noticed Litecoin.

“Cryptocurrency markets flying.”

“Litecoin up 30%.”

“Bitcoin surges 8%.”

Reading articles with this type of headline is like eating the wrong half of a large chocolate bar. The body releases hundreds of chemicals one of which is phenylethylamine — a neurotransmitter, chocolate opium. As you eat, endorphins trigger in the brain, raising the blood pressure, increasing excitement and awareness. But after the rush, there’s a feeling of discomfort, as your body deals with the sugar rush. And so it is with this type of article.

“Litecoin rides the bull.”

Here’s the reality.

This type of headline is designed to do one thing. Click. Eat.

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But just like the chocolate bar, most articles, after the click-me headline, malaise off into oblivion using words like: might, could, and should.

Instead of wasting time reading this type of article, the 5% use relative strength analysis. (Not to be confused with the relative strength indicator, RSI.)

To use relative strength, you use a ratio. For example, if you want to find the relative strength of Litecoin to Bitcoin, you already have a useful symbol — LTCBTC.

And this leads to an important question….

Benchmark

LTCBTC chart

LTCBTC chart

If you take a look at the LTCBTC chart, you’ll see that Litecoin has been outperforming Bitcoin since mid-December 2018.

LTCBTC chart

LTCBTC chart

One thing you’ll notice when checking out the Litecoin to Bitcoin chart is the absence of the 2017 parabolic trend. This is because LTCBTC is a ratio priced in the number of Bitcoins it takes to purchase one Litecoin.

So far, Litecoin price has varied between around 0.003 Bitcoin at the lower end of the range to approximately 0.024 Bitcoin at the top end. Apart from a brief price spike in July 2015, this range has defined how Litecoin and Bitcoin perform against each other.

Because LTCBTC is a ratio, you could say that near the bottom of the range Litecoin is undervalued against Bitcoin, and near the top of the range, Litecoin is overvalued.

Of course, this is true for fiat currencies too. The exchange rate EURUSD is a ratio. It’s the ratio of how many US dollars it takes to buy one euro. In the same way, GBPUSD is the ratio of how many US dollars it takes to purchase one British pound.

Let’s take this further. In foreign exchange, currencies are quoted like this: BASE/QUOTE.

In EURUSD, the euro is the base currency, and the US dollar is the quote currency. The BASE/QUOTE ratio is the same for all currencies.

The euro, the British pound, the Australian dollar, and the New Zealand dollar, use BASE/QUOTE and use the US dollar as the quote currency. New traders get confused because not all currencies use the US dollar as the quote currency.

Take the USDJPY exchange rate. The US dollar to Japanese yen rate has the yen as the quote currency. It’s the ratio of how many yen it takes to purchase one US dollar.

EUR/USD

EUR/USD

The reason this is confusing to newer traders is that when viewing a performance chart of the EURUSD, when the price is going higher on the chart, it means that the euro is outperforming the US dollar because it takes more US dollars to purchase one euro. Same with the Australian and New Zealand dollar and the British pound. When these charts are going up, it means US dollar weakness.

USDJPY chart

USDJPY chart

But when viewing the USDJPY chart, this time the US dollar isn’t the quote currency, it’s the base currency. If the price of the USDJPY is going up, it means it takes more yen to purchase one US dollar, in other words, USDJPY going up means US dollar strength — not US dollar weakness.

If the USDJPY is going down, it means US dollar weakness. Why? Because the US dollar is the BASE currency and it takes less yen to purchase one US dollar.

The Swiss franc and the Canadian dollar, like the Japanese yen, are quoted using the US dollar as the base currency.

The EURUSD, GBPUSD, AUDUSD, NZDUSD, USDJPY, USDCHF, and USDCAD are known collectively in foreign exchange as the majors. They represent the eight major global fiat currencies.

But what if you want to find out how many Japanese yen it will take to purchase one euro?

The EURJPY exchange rate is called a cross rate.

The euro is the base currency and the yen the quote currency. If the EURJPY is quoted as 124.21, this means it will take 124.21 yen to purchase one euro.

If a chart of EURJPY is going up, it means it takes more yen to buy one euro. This is euro strength, yen weakness. When the EURJPY is going down, it means it takes less yen to buy one euro. This is yen strength, euro weakness.

Let’s say you have Japanese yen, and you want to buy euros. For you, a retail trader, you can use the EURJPY cross rate. But cross rates are less liquid than the major rates, so what would you do if you were a large institution which needed to establish a long EURJPY position with 100 million euros?

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You buy EURUSD, and you’d buy USDJPY. By going long both of the major rates, you are effectively long euros short yen. This process is called legging in.

So why are we talking about foreign exchange? What’s all this got to do with cryptocurrencies?

How do you measure your success? What terms do you use to mark your cryptocurrency profit and loss to market?

Did you make 1.2 bitcoin this week, or did you make $4,440?

In 2019, wealth isn’t measured in Satoshi. It’s measured in US dollars or your local fiat currency.

One of the reasons for this is volatility. If traders didn’t care about fiat currency, they wouldn’t use stable coins.

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In PowerBall, we discussed the historical volatility of cryptocurrencies and compared them to forex exchange rates. If you check out the level of volatility in the EURUSD and compare it to Bitcoin, or Litecoin, you’ll understand why success is measured not in cryptocurrency, but hard fiat currency.

The 5% decide on a benchmark and stick to it.


Out of Control

When you see charts with sensationalistic titles, ask yourself, how are you recording your wins and losses.

In early February 2019, Litecoin is showing positive relative strength compared to Bitcoin, and there are plenty of headlines declaring that Litecoin may be in a bull market. Again, take notice of the word “may” as few article writers will commit to saying “is.”

One word being used by headline writers to describe the move is “surging.” It’s an emotive language designed to get your attention.

The majority, the 95%, spend their time reading articles with emotive titles because they are looking for the one thing that can be guaranteed. They are searching for certainty, for any scraps of information that tells them it’s ok to proceed.

The 5% know nothing in speculation is guaranteed. Nothing. The consistency the 5% enjoy does not come from reading articles on who said what, or what the 50-day or 200-day moving average are doing.

When you enter into a trade, you could have the best research out there, and you could be absolutely right over the long term, but nothing you can ever do will guarantee anyone order will be successful. For example, you might have figured out the likelihood of a move, because of favourable background conditions, is in your favour, and so you enter a position.

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Unfortunately, seconds after your order is completed, a large order in the opposite direction hits the order book, and your well thought out long position is now losing money and facing a cliff-edged sell wall right above your entry price.

The 5% understand controlling the order flow is a complete waste of energy and effort, and it’s mentally draining too. The 95%, in contrast, have not yet figured out that anything can happen at any time and that controlling the process is impossible, like trying to hold back the tide. The 5% know this is one of the cornerstones of success.

The 95% read articles, they learn technical analysis, and they take positions. When they take the inevitable losses, they beat themselves up, reinforcing their emotions with negative statements, while attempting to protect their id with their ego.

When building a long term position, events beyond your control can and do happen. The 5%, instead of finding something to reinforce their beliefs, use money management and position sizing to manage their risk.

When you look at a chart of Litecoin, first check if it’s LTCBTC, Litecoin priced in Bitcoin, or LTCUSD, Litecoin priced in US dollars.

Litecoin priced in Bitcoin shows a sideways movement, with prices trading between upper and lower levels. This is because the cryptocurrency markets are highly correlated. Litecoin has a rolling quarterly correlation coefficient to Bitcoin of above +0.75, and this means that most of the time, Bitcoin and Litecoin move together.

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While it’s true, in early February 2019, this relationship is weakening.

That’s why, when you look at a chart of the LTCBTC cross, the parabolic trend in late 2017 is cancelled out because both Bitcoin and Litecoin had parabolic moves.

Outside of cryptocurrencies, two commodities that have a high correlation of over + 0.75 on a rolling quarterly basis is gold and silver.

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Using the gold to silver ratio, GC/SI, over the last thirty years it has taken between 32 and 101 ounces of silver to buy one ounce of gold. The average is around 65.

When trading at the extremes of around 32 or 101, silver is undervalued or overvalued respectively in terms of its price relative to gold.

Using your eye, you can draw a simple average at 65. It’s the midpoint between the high of 101 and the low of 32, and while not exact, it takes seconds to visualise. This gives you valuable information. At some point in the future, the ratio of Gold to Silver has a high likelihood of returning to the mean of around 65.

Around 65. Not 66.5? This is where engineer types and people coming into speculation from professions that demand accuracy have trouble. In their world, “Did you tighten that bolt to XYZ?” requires an exact answer — maybe isn’t good enough. But trading and speculation is not engineering, although some might argue it is.

Engineer types, like to fiddle with the math. They use the skills that made them successful in their chosen career and attempt to port these skills over into trading and speculation. They use their math skills to write indicators, with some even taking it a step further, investing in or even writing their own automated quant-based systems.

It’s not math. It’s not the pinpoint accuracy. The numbers break down the same way, with 5% of engineer types being consistent and successful, leaving the rest struggling.

The difference? 5% of traders and speculators who write their own indicators and systems do so to exploit edges they understand, and not to reinforce someone else’s analysis or opinion.

Speculators use many different tools to trade edges, and the 5% who become consistent with their results, do so because they have found a method that’s in line with their temperament and risk tolerance.

In Top Ticked we discussed the squawk box, a tool used by many successful speculators until they were outmoded as trading moved off of the trading floors and upstairs in the offices. Squawk boxes measured the activity in the trading pit. Skilled users could time entry and exits based off of nothing more than momentum shifts in the decibel levels.

Exact? No. Accurate? Yes.

Consistency comes from understanding what you are looking for. The 5% search for exploitable edges, the 95% search for validation.

While articles talking of a new cryptocurrency bull market abound, LTC/BTC is trading exactly where it historically does. Right at the mean between the extremes.

Instead of allowing themselves to be influenced by hyped comment and quote articles, like the ones being posted right now all over the internet, the 5% take a step back and look, not only at the LTC/BTC cross rate, checking if Litecoin is near an extreme, but they also watch out for breakouts, not just in terms of Satoshi’s but also in terms of US dollars.


The Turtles

Probably, the most used entry technique is the breakout. The problem is, the breakout technique is one of the lowest probability entry techniques in use today. The breakout technique can be used as an effective entry method; however, most people who use it don’t achieve the results they expect.

Why?

The reason is simple. Most traders don’t understand the probabilities and likelihoods associated with the breakout entry.

The 95% searching for certainty, enter late, out of position, having little or no position sizing and no understanding of how often a breakout trade can fail.

In 1982, in the movie Trading Places, Randolph and Mortimer Duke made a bet. Could they take someone off the street and turn them into a successful professional trader, and at the same time if they put a man brought up in privilege, with an Ivy League education and put him on the street would he be successful — could he survive?

The movie is a work of fiction, but in 1983, two commodity traders Richard Dennis and William Eckhardt had an idea. Could anyone be taught how to be a successful speculator?

Dennis thought yes, Eckhardt was not so sure. Dennis, who had turned a $5,000 stake into more than $100 million trading the futures markets advertised to recruit people. They were called the Turtles, named after Dennis had come back from holiday where he spent some time at a turtle farm.

The premise: Traders could be grown — made, as easily as turtles at the farm.

The bet was on.

Out of the thousands of applicants, only thirteen were initially chosen.

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The new traders were taught a simple breakout system. When the price traded one cent above the previous 20-day high, buy. If the price breaks a ten-day low, then sell. (In actual fact, there were two breakout systems, and the new traders could pick which method to use. The entry was slightly more complicated in real life, because of money management and position sizing units. But the idea is the same. Buy the x day highs, or sell the x day lows. If you look, you’ll find the original turtle rules are available free online.)

Dennis funded each of the traders with between $500,000 and $2,000,000. Most could not follow the rules — even though they were not trading their own money. A few, who did, were wildly successful — the rest failed and were cut from the project.

The turtle system wasn’t just about the entry. Traders also had to consider the markets they would be trading, how much to purchase on each trade when they would cut a losing position, when they would get out of a winning position, and the trading tactics of entry and exit.

They needed to consider inter-market correlations. The turtle rules broke available trading capital down into units. The units used normalised volatility to control risk. This sounds complex, but it’s not.

The turtles calculated the 20-day average true range of the market in question and multiplied it by the dollar value of the underlying market per point. This gave the dollar volatility adjustment.

Units were created for each market by taking 1% of the account size and dividing it by the volatility adjustment.

When trading breakouts in the basket of markets, the turtles had limits on the number of units they could allocate in certain situations. For example, they could only allocate a maximum of four units in any one market, a maximum of six units across highly correlated markets, and a maximum of ten units across non-correlated markets. The unit allocation helped to dampen the results equity curve.

The biggest problem with the turtle system was the drawdown. Turtle traders expected to have large drawdowns, yet even though the drawdowns were significant, if the traders stuck to the rules, following the strict money management and position sizing, they had a high likelihood of making a profit. Most couldn’t do it.

Most of the turtles, fiddled with the settings, missed some trades because they didn’t believe the underlying market would go in the intended direction, because of some outside influence, maybe a comment from a respected financial pundit, or an article in the newspaper, and changed the amount of money they put at risk.

The traders who failed in the turtle program, failed because the system risk tolerance did not fit with their own. Even when trading with Richard Dennis’s money they could not follow the system.

A breakout trading system can be profitable, but to use it to become a consistent speculator requires you to understand the exact entry, position sizing, and money management techniques that make the system successful. The 5% take the time to learn these skills. The 95% don’t.


Painting the Tape

The turtles used a mechanical entry technique, but behind the scenes, the money management and position sizing components acted like a backup system, lowering the probability of catastrophic losses.

Most people who attempt to use breakout systems only use the obvious part - the entry, failing to understand it’s the hidden variables behind the scenes that make the difference between profit and loss.

Markets move because of a shift in supply and demand. It’s estimated that most of the cryptocurrency volume takes place OTC, or over the counter.

If you use a regular exchange when attempting a large cryptocurrency transaction, then you won’t be able to complete the transaction without affecting the underlying price. You’d have to break the order down and that would expensive in terms of fees. The solution, not available to the general cryptocurrency trader, is to use an OTC market.

Many of the large exchanges provide OTC services for clients who have transaction sizes of at least $100,000. For example, in late 2018, Coinbase quietly rolled out its OTC service for “institutional” clients. Let’s say one party wants to undertake a $1 million Bitcoin transaction. Coinbase acts as the agent, facilitating the trade without alerting the exchange customers that a massive deal is taking place as the OTC transaction doesn’t appear on the exchange order book.

OTC trading gives rise to Dark Pools. When two parties want to conduct trade, anonymously, away from the exchanges, one option is to use a Dark pool — an anonymous dark transaction with enough liquidity or depth to enable the deal to take place.

These liquidity mechanisms are not illegal.

Understanding OTC and Dark Pools exist, and that the volume of transactions that go through them are greater than the transactions on the public exchanges, and you’ll begin to understand why you have no control over what happens once you have made a trade.

The 5% use the price cycle as a construct to figure out the likelihood of prices moving out of one phase and into another.

Litecoin has broken out of its 200-day moving average when priced in Bitcoins, but by checking the price action of Litecoin against the US dollar, you’ll be able to see the bigger picture.

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In Deus Ex, we introduced the price cycle. A framework used by the 5%, the most consistent and successful speculators and investors, to place a cryptocurrency in either, a downtrend, a sideways accumulation pattern, an uptrend, or a sideways distribution pattern.

In previous articles, we talked about emotion bars, the signature of the crowd reaching a peak of emotion, and getting out at any cost. After an emotion bar, a wide-ranging bar, on a daily timeframe closing in the top 50% of the day’s range and accompanied with very high volume, the 5% know the likelihood of a transition into a sideways accumulation pattern has increased.

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The key is that during a sideways accumulation pattern, the 5% are looking for a different type of price behaviour. After the masses are out with losses, usually a considerable amount, a market will consolidate for some time. When a market is consolidating after a long down move, and after the appearance of an emotion bar, the 5% focus on breakouts of previous highs and tests of previous lows.

Financial markets, including the cryptocurrency markets, are complex systems. A down move on its own means little, but by combining and stringing together a series of actions the 5% can assign a probability to the next series of moves.

After a down move, an emotion bar, an initial rally from the emotion bar that fails and multiple tests of the emotion bar selling tail, the 5% wait for a big move up on very high volume.

Cryptocurrency markets, like all financial markets, don’t make exact behaviour patterns, but they do rhyme.

The reason the 5% use the price cycle is that, depending on where they place price within the sequence, they assign a different meaning to a particular type of bar.

As an example, in an uptrend, a wide range bar on high volume very often pauses the trend or even ends it. It’s a neutral or bearish behaviour.

However, after sideways accumulation move with multiple failed highs and tests of lows, a breakout from a high on high volume is assigned another meaning. It’s bullish.

Why?

For prices to move up out of a sideways accumulation pattern and into an uptrend, new demand has to overwhelm overhead supply. When prices break out to new highs from a sideways accumulation phase, it’s direct market feedback that the overhead supply or selling has been used up, and if no sellers are willing to sell, it will take less buying effort to move prices higher.

Litecoin looks like its broken out to the upside when viewing it against Bitcoin, but if you checked Litecoin’s performance against the US dollar, you'd see it the up move took place with a wide range bar breaking out of a previous high, on high volume. Litecoin is attempting to break out of a short term sideways accumulation base.

In early February 2019, the cryptocurrency markets appear dead but look underneath the surface, and you’ll discover lots of activity in the Over the Counter (OTC) market.

For now, the trend of the cryptocurrency markets is down. The 5% are watching the breakouts from bases and noting the off-exchange volume, looking for clues the overhead supply is used up.