How to trade Bitcoin smartly: Technical analysis primer
You now know that bitcoins behave like usual shares or currencies. It means you can apply all the powerful methods of technical analysis — that’s the collection of tools that was developed for professional traders and have made many of them astonishingly rich. Of course, you need to be smart (and, if you are reading this book, you definitely are!) to outsmart the market and the brave. And, we have to add the usual disclaimer: only invest money that you can afford to miss. Never invest borrowed money as you might end in deep trouble otherwise.
What is the idea of technical analysis in a nutshell? —It is very simple. You can gain much more for your investment if you do not just sit and wait, but rather use the cyclic character of price
evolution and sell your stock (here bitcoins) when the price is high and buy them again when the price is low. To do it properly, you need to determine the trend and find the right moments when the trend is reversed.
Trend is your friend
Let us start with determining the trend. The easiest thing to do is to use a moving average. That is a very simple approach that you can try in your Excel spreadsheet in a matter of minutes. I will show you how. The point is that the price always fluctuates. Your averaging algorithm has to smooth the fluctuation sufficiently, on one hand, while still showing you the changes in the trend as soon as they occur (this property is called responsiveness). Obviously, these two requirements are orthogonal, and you need to balance them. Simple moving average (SMA) involves just taking the price for a given day,
add to it the prices at a given number of previous days and divide the sum by the total number of days. So, the value of every point of your
SMA graph is (I take here an average over 10 days):
The problem with this sort of averaging is that you take into account equally the today price and the prices that happened many days
ago. As a result, your SMA10 curve predicts tomorrow’s price mainly based on the prices from several days ago. For such a volatile currency as Bitcoin, this
is not a very good idea. To correct for that, you can take more recent price values with a higher weight in your averaging. The simplest realization of the weighted moving average (WMA) would be just to account for the most recent price twice.
Or, for our SMA10, we can
multiply the current day price by 10, the previous day by 9 and so on.