While we are waiting for bitcoin to complete the ending diagonal by moving towards, or near, the downsloaping support line at approximately 5555$ (what's in a number?), before we move up towards 55555$ (more crazy numbers), let's review the philosophical base of technical analysis.
The philosophical base of technical analysis consists of three concepts:
- markets discount all information with the resulting consensus being the current price.
- prices move in trends.
- situations tend to repeat themselves making it possible to define and identify patterns that reoccur, therewith giving these patterns some predictive value.
The above three concepts are the philosophical base of technical analysis. Let's see if we can arrive at them from a set of logical axioms. In other words, let's dive into the epistemology of trading, meaning asking the question: what do we actually know?
First of all, all value is subjective. This is standard economic theory that follows from the Marginal Revolution. People value goods based on their utility for the current place and time. Period. Consequently, there is no intrinsic value. Intrinsic value, usually referring to gold, silver or jewels, is simply the historical recognition that before mentioned goods always have held value throughout the ages and therefore most likely will remain valuable in the centuries to come. Nonetheless, their value is subjective, not intrinsic.
Because there is no intrinsic value, you also cannot calculate value or calculate an aggregated value by summing up individually calculated values. For instance, there are many, many shares, especially in smaller, local markets - no blue chips - that trade a very low P/E levels. Often the price does not even reflect the assets the company possesses. This is however no guarantee that the price will go up. If nobody wants to buy the thing, prices will stay depressed; and they can stay depressed for a long time.
Because all value is subjective, and because price is the ever changing consensus between all these subjective valuations of buyers and sellers, and because this consensus changes gradually, provided there is a large enough amount of buyers and sellers, prices move in trends: trends up, down and sideways.
With regard to these trends, the famous saying from Mark Twain seems to apply: history does not repeat itself, but it rhymes. These trends - which have historical similarities - also rhyme. In other words: trends are similar but never the same.
So, by praxeological reasoning (sort of) from the subjective value axiom, we have established that prices move in trends that are similar but never the same. Good! How are we going to profit from that? Do we need more?
Problems we face are:
- How do we determine if a trend exists?
- Can all trends be traded for a profit?
ad 1. Let's not go into the methodologies for trend detection as there are many, from drawing trendlines, to hundreds of indicators, Elliott waves and what more. None of them is perfect and usage depends on personal preference. None of them is perfect because all technical tools follow reality and they may indicate a trend when it has in fact already ended.
ad 2. Since the future is uncertain by definition, we can never know in advance if a trend, once established - irrespective of the method used - is going to be a strong trend or a weak trend. We can never know in advance, with any certainty, if trading the trend will be a profitable affair.
Nonetheless, while the future is uncertain, we must all make predictions about the future. Whether you move house, change job, start a new relationship, divorce, have children or buy crypto. In all cases you are making a statement about the future. At the time you think it's a great idea, but certain you cannot be. Fortunately, with investing or trading, you can settle for a loss. This is not always a possibility with other choices.
In addition, because all market participants have different time preferences, trends never move up or down in a straight line. Therefore in any trend, prices switch between overbought and oversold positions. Most notably, in a larger uptrend, meaning there are strong moves in the direction of the trend (impulse or motive waves), these moves continously alternate with slow, more horizontal moves (corrections or periods of profit taking).
Consequently, you can identify a larger scale trend, zoom in to a shorter time frame, and simply buy the oversold or sell the overbought situation in a shorter time frame correction.
My own personal preference therefore, based on above observations, is to first determine whether a trend exists on a higher time frame; let's say we have an uptrend on the 2 hour chart, then drill down to a lower time frame (15 minutes for instance), wait for an oversold situation there, meaning prices touch the lower Bollinger Bands. Then, go to the 5 minutes chart and open a long position once some indicator gives you a signal to. Stoploss and profit stop, both on the 5 minute chart according to some methodology.
The approach is logical and it addresses the main uncertainty we face, namely: how to know if a trend can be traded for a profit? Well, we can't; but we can improve our chances by playing on an assumption and taking small chunks of that trend. Now, in testing it seems to work fine. In realtime it's more diffcult as emotions and discipline play an important role.
The above is of course a short term approach for which you need to use a short term instrument like futures.
You can do the same on a medium term time frame, let's say a 3 hour or 8 hour chart time frame, by simply trading in the direction of a higher trend whenever an oversold or overbought situation manifests itself. For a medium term time frame credit spreads look interesting.
Last, and I find this to be the most reliable technical signal, we have long term breakouts on a weekly chart. Meaning a breakout out of a long term downtrend accompanied by strong volume. That almost always produces a good uptrend, especially if the general sentiment as indicated by the major index is positive, meaning there is limited negative sentiment to slowdown the enthusiasm of the breakout. It's true that the method is less sophisticated: no fancy indicators, no integration of time frames, only trend accompanied by volume. I find it to be the easiest and the most reliable way to trade. This is of course a long term position and must be played by buying the underlying value. Stoplosses do not apply. Should it move against you, you hodl and possibly add to the position when a new long term signal is given.