Bitcoin – What To Know Before Investing In It (22)

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5 Things You Need to Know Before Investing in Cryptocurrency

Crypto fell off a cliff in 2020 and no one really knows why. You’ll find a hundred different rationalizations on the net. If you had to ask me, I think that the crypto market got ahead of itself in 2020. That’s what happens every time a new technology comes along (just like dot.com era). A lot of hype and prices rise too fast. And the faster the price of Bitcoin and other coins rose, the more fragile the bull market became. Investors who bought Bitcoin for $50 were not sensitive to price changes at $10,000, $15,000 or $20,000.

However, Bitcoin holders who bought at $19,000 probably rushed to sell their holdings when the Bitcoin price dropped to $15,000. As the bull market progresses, the risk of a major sell off increases. And this is what happened.

At the end of 2020, investors started realizing their gains which caused a minor correction. Then investors who came late to the party saw red in their crypto portfolio so they also started selling their holdings. Further selling means further price declines and that’s how a deep market correction develops.

The market correction brought down everything with it and you ought to be particularly careful with your crypto investments, especially if you participate in new ICOs. You are investing your hard earned income in crypto so make sure you get all the help you need.

To get you started, have a look at the 5 basic rules you need to know about investing in crypto.

1. Understand the risks you’re entering into

Make sure you understand the inherent risks you’re undertaking when buying crypto currencies (more specifically utility tokens).

  • When you buy into an ICO, you are buying into a startup. Most startups fail.
  • Most crypto (especially tokens that can’t be used yet because the platform is not live yet or in its infancy) is illiquid and easier to manipulate than securities
  • Crypto tokens (bar security tokens) don’t pay a dividend
  • Crypto markets are unregulated so a few big boys might corner the market at your expense
  • Also, what the Whitepaper states is rarely reflected in the Smart Contract and even worse, the founders sometimes keep the back door open in case they wish to amend the Smart Contract in the future (e.g. they allow themselves to change the supply of a coin after the ICO; or the Whitepaper mentions a lockup period but the Smart Contract doesn’t have any logic that locks up founders’ tokens). See here if you’d like to read more about this

2. Don’t be Silly

I get it – you see a few token shooting through the roof and you want to join the party. Crypto is risky – for the reasons I mentioned above. Start with small amounts and don’t go all in.

Keep your exposure to crypto to a reasonable level (and stick to it!). My current exposure to crypto is 5% of my total investment portfolio. I might consider upping it to 10% if the market goes much lower but 10% is my hard limit. Of course my exposure limit should be different to yours and your exposure limit depends on your age, your income, your level of wealth and in which asset classes you’ve invested your wealth in. Don’t copy my exposure limits!

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Also, diversify your crypto holdings – especially in an asset class that largely depends on the speculation that a certain DLT platform will become popular. The more you spread your coins, the more likely you’ll hit the jackpot.

3. Be choosy

A deep market correction (including the crypto correction) brings everything down: good and bad tokens. Given that you’re within the exposure limits you’ve set yourself, buying during a severe market correction means you have the opportunity to shop around for great tokens at a deep discount.

Look at the drivers that support the price of a token

Go after those tokens with a strong, fundamental demand for the platform they support. Let me give you an example to show you what I mean.

You buy computation power on Ethereum by paying for Ether. Creating a new Smart Contract on Ethereum costs Ether; executing smart contract logic costs Ether and so on. Given that Ethereum seems to be the platform of choice to run Smart Contracts and in a world moving to automation and decentralization, one may take a position in Ether on the expectation that the demand for Ether (to execute even more Smart Contracts on Ethereum) will be strong.

If the thesis is correct, strong demand for executing Smart Contracts on Ethereum will underpin the value of the token in the long term.

Look for large economic moats

I’m not reinventing the wheel here – I’m borrowing the term from Warren Buffet, one of greatest investors out there. Economic moat refers to the degree of competition an Issuer faces (or will face in the future).

There are some business models which are harder to emulate than others. It’s hard to copy the brand loyalty that Apple has and it’s also not easy to build a double sided market place like eBay. On the other hand, it’s less difficult to build an Android-based phone and compete with Samsung. And, LED TVs are sold at low margins in a saturated market. Get the idea?

And this links to the point I made in Section 3.1 above. Most popular Altcoins execute the same function, have similar levels of market capitalisation and are (generally) equally accepted. In other words, they’re interchangeable. Buy coins that give you access to unique platforms if you want to sleep at night – especially in the current market conditions.

4. Don’t be Lazy

If you really insist on buying into ICOs, you need to get a lot of dirty work done. Around 600 ICOs went to market in the first half of 2020 (and I’m not mentioning those ICOs which didn’t reach their soft cap!) . That’s a lot of Whitepapers to analyse. Being a hard worker isn’t enough though:

  • You need to make sure you’re good at distinguishing a good startup from a bad one
  • You need to look at the founders, their expertise and their track record
  • Determine if certain major organisations are backing the blockchain application or otherwise

Or you can engage an advisor which does this. Really and truly, you need a team of analysts to sift through Whitepapers on an ongoing basis.

5. Technical Analysis is key

In a token world where no dividends are paid and no earnings are attributed to (utility or payment) tokens, it’s quite impossible to determine the fair value of a crypto asset (in the traditional finance world, the price of equity is a function of the future dividend that the Issuer is expected to pay). How much, say is Bitcoin worth? Coming up with a reply is impossible. If you can’t value an asset you can’t determine if you’re over paying for it or otherwise. It’s like walking blindfolded.

Technical analysis may come in handy (but trust me, it’s not a perfect science). Technical analysis is basically a study of how the psychology of the market is manifested in how a chart for an instrument looks. For example, when prices are going up and volumes dry up, you ought to be very careful with that price movement because it indicates that a very tiny portion of the market is participating in that price increase. Conversely, if there’s a market correction accompanied with large volumes in that token, then it should mean that the correction is supported by a relatively large portion of the market.

Technical analysis helps (I underline, helps but is not a silver bullet) avoid catching a falling knife or buying at the top.

Again, get help on this – or if you’re interested in learning how to read charts, read a few books on the topic. You can start with this one: Short Selling with O’Neil Disciples. It’s a great book, but beware: it’s not a page turner!

Bonus: Replies to standard questions I usually get from crypto investors

I usually get a common set of questions from crypto investors so I thought of reproducing them together with my standard replies.

I bought crypto in 2020 and I have not sold them yet. What should have I done to avoid the 2020 carnage?

It’s never easy to spot a top even though it’s obvious in hindsight. However, there are a few things you can look out for:

Remember that bull runs get more fragile over time, especially if it rose super fast (Bitcoin rose from $1,000 to $20,000 in 1 year!). The first major drop after a crazy major bull run is a red flag. Prices usually recover after the first correction but that is a dead cat bounce. It almost always happens and you should not trust it. Make sure you start selling at this point. You might possibly get it wrong (and the market continues rising) but the odds are against you. I would sell half my position at this juncture

Click to Enlarge

If the price drops below the 20 day and 50 day moving average (after a bull run) sell more or all of your remaining holdings

Click to Enlarge

The indicators I mention above are generally visible at the onset of each major market correction. They’re not fool proof but they’ll likely to get you out of trouble more often than not. I’d rather miss out on the last part of the bull run as long as I minimise my losses.

I bought at the top and lost a lot of money. Should I sell now to cut my losses?

You will probably see more red in your crypto portfolio but it is probably the worst time to sell your assets now. For example, if you bought XRP (Ripple) at the top, 90% of your investment has been wiped out (sorry if I’m putting salt on the injury!). In your position I’d hold on to the last 10% and see what happens.

Will the carnage continue?

Probably. The market has been in decline (identified by a series of lower highs – i.e. each subsequent high is lower than the prior one) since the beginning of the year. As long as the pattern doesn’t change (i.e. lower highs persist), it’s likely that the market will drop further.

Click to Enlarge

Should I buy now?

Wow you’re bold! If you’re not overexposed I would start dipping my feet when the market consolidates around a bottom (there are many things to look out for and one of them is the pattern of lower highs is broken). Learning to read charts will be a great help to you, take a look at some of our trading guides to get started :

Bitcoin And The Demise Of The ‘Digital Safe Haven’ Narrative

“There is no alternative [to equities]”

“Don’t fight the Fed”

“Buy the F*ing Dip”

“Interest rates have nowhere to go but up from here”

“COVID-19 is contained/just the flu/only killing old people”

There’s no shortage of market narratives that have collapsed over the last two months, but for cryptocurrency traders, the implosion of the “bitcoin as a digital safe haven” meme may be the most significant.

Like just about every other major asset, with the possible exception of U.S. Treasury bonds, traders dumped digital currencies relentlessly earlier this month in a mad dash to raise cash (specifically U.S. dollars) from any liquid asset. At least when it comes to “The Great Cessation” of economic activity as countries across the globe shutter in unison, Bitcoin has served as a poor store of value in recent weeks.

Of course, the massive response from both fiscal and monetary policymakers should theoretically benefit Bitcoin in the long run. After all, the cryptocurrency’s hard-coded cap on supply of 21M bitcoins and relatively low new issuance (poised to drop below 2% after May’s “halving” of the supply) contrasts more starkly than ever with the profligate spending and money “printing” from major governments and central banks. That said, investors tend to focus on quality and cash flows through recessions, so they’ll likely be reticent to aggressively bid up a barely 11-year-old digital “asset” that has seen repeated drops in excess of -70% in its short life, including over the last 9 months!

In any event, Bitcoin has at least stabilized over the last couple weeks after the panic-driven mid-month collapse to below $4,000, with the Fed’s aggressive liquidity injections playing a role (astute traders will note that gold has also rallied strongly in recent days ). From a technical perspective, the cryptocurrency is still trading below its 21-day exponential moving average, a proxy for the short-term trend, as well a key previous-support-turned-resistance level at $6600:

Source: TradingView, GAIN Capital

In the short term, continued consolidation below $6600 resistance would be seen as a bullish, especially if equity markets and risk appetite more broadly turn lower again. Of course, a confirmed break above this level would be a strongly bullish sign and could suggest that traders are recognizing Bitcoin’s potential, even if the “digital safe haven” narrative has failed this test.

Finally, a break back below the weekly low around $5700 would be a bearish development and could foreshadow another leg lower toward $5000 again.

Where Are Bitcoin Prices Headed?

Bitcoin rallied nicely late last week and retook the $8k level. This is the first time since November the cryptocurrency has traded this high. This latest bounce inevitably leads us to the more important question, where are prices headed next?

The most obvious place to start is the attached chart. You don’t need to be a Certified Master Technician to see the problems with Bitcoin’s chart. On multiple timeframes, this currency is experiencing a strong downtrend, most evident by the clearly defined pattern of lower-highs. Last year’s bounce to $10k was impressive and I was cheering for it the entire way, but at this point, it looks like that rebound ran out of energy and every subsequent bounce has been lower and lower. The biggest point of concern is in the mid-$6k range. This is where Bitcoin prices collapsed last time. We still have a bit of a buffer, but things could get real ugly if we return to this critical tipping point.

Bitcoin is setting up for a nice trade here. Hold above $8k and everything is great. But if support fails, look out below. The most obvious way to trade this is buying a move above $8k and shorting a dip under it. While this strategy will inevitably lead to a few whipsaws along the way, no doubt the next big move will start from here and it could go in either direction. I don’t mind getting whipsawed a little over the near-term if it means I will be in prime position to catch the next big move. The best way to manage these nuisance whipsaws is to start small and only add to your position after the trade starts working.

All of that said, given this sickly looking chart, if I were forced to choose, the most likely next move is lower and chances are good prices will undercut last year’s $3k lows. The only hope this has over the near-term is if we break through $12k and end this pattern of lower-highs for good.

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