Is it possible to successfully trade bitcoin and other digital currencies? The short answer is, “Yes.” However, there are several caveats attached to this answer. For starters, novice traders should be fully aware that buying and selling bitcoin is not a “get rich quick” scheme. On the contrary, becoming a successful digital currency trader or investor requires a tremendous amount of dedication, patience, discipline and good old-fashioned hard work. Profitable bitcoin traders view digital currencies as simply another asset class. They approach bitcoin in the same manner as stocks, bonds, commodities, forex and precious trametals. Very often, they trade digital currencies using the same techniques and methods as other asset classes.
Let’s review a few successful trading strategies used to trade bitcoin. Always remember, there is no single perfect method to trading digital currencies. Instead, the most prudent approach is to develop your own trading style and methodology using basic techniques listed below as a frame of reference.
#1 Follow the Trend
Without question, this is the most important strategy among successful traders. The road to profitable trading is littered with frustrated speculators who failed to follow this simple strategy. All financial markets operate under the same basic premise which says that trending markets are statistically inclined to continue moving in the same direction of the prevailing trend. Traders who fail to adhere to this basic concept are doomed to failure.
If trend following is such a great strategy, why do most speculators trade against the trend or simply ignore the trend of the market? Because trend following is a very boring strategy. Quite often, it will take several weeks or months for a sustainable trend to develop. Consequently, traders are forced to wait patiently on the sidelines until a trend emerges. Unfortunately, the vast majority of speculators simply don’t have the patience to wait for a trade to develop. Of course, this explains why most traders lose money.
What constitutes a trend? By its very nature, trend following is a very simple concept. Therefore, determining the trend of the market needs to be clear and concise. The purest way to calculate the trend of any market is to use a moving average. If the market is trading above its moving average, the trend is bullish. If the market is trading below its moving average, the trend is bearish. There should be no confusion as to the trend of the market. It’s either bullish or bearish, nothing in between.
In terms of bitcoin, the best way to calculate the trend is to use a 20-day simple moving average (20 SMA). Many traders use 5 days or 10 days in their calculations. However, due to its volatile nature, bitcoin does not work well with short duration moving averages. The best number to use is 20 SMA.
During the past few months, 20 SMA has generated two powerful trading signals. Please review the following table. For those who prefer a pictorial view, please examine Chart #1.
Note: The squiggly line on the chart is the 20-day moving average.
20 SMA Trading Signals
|Entry Date||Entry Level||Exit Date||Exit Level||Profit/(Loss)
Of course, trend following is certainly not perfect. This trading approach does contain a few flaws. For example, trend following has a tendency to generate false breakouts. Traders will get “whipsawed” when the market is stuck in a trading range, which could produce several small losses. However, over the long run, this method will generate enough big winners to offset the small losses.
Always remember, there is no “magic formula” to profitable trading. However, 20 SMA will definitely keep you on the correct side of the prevailing trend, which is critically important.
#2 Volume is Important
Very few traders pay attention to volume. This is a mistake because volume can provide several clues to the underlying strength or weakness of the market. It can give early warning signs concerning a possible change in trend.
The most prudent way to use this indicator is to compare and contrast the daily volume on a big up day or a big down day. If a bullish breakout is not confirmed by record volume, it’s probably a false breakout. Additionally, if a bearish breakout is not confirmed by record volume, the most likely outcome is a false breakout. Please review the following table. For those who prefer a pictorial view, please examine Chart #2.
Using Volume to Confirm a Breakout
|Date||Breakout Level||Bitcoin Volume||Confirmation
|10.13.2017||5403||210,617||Breakout was confirmed
|11.29.2017||9968||332,437||Breakout was confirmed
|12.18.2017||17948||125,859||Breakout was not confirmed|
|12.22.2017||14322||219,521||Breakout was not confirmed|
As you can see from the table and the graph, bitcoin generated a bullish breakout on 10.13.2017. This breakout was confirmed by a record volume of 210,617 bitcoins. Another bullish breakout was confirmed with record volume on 11.29.2017.
The massive bull market in bitcoin ended on December 18, 2017. You will notice that this final bullish breakout was not confirmed by a new record in volume. In fact, only 125,859 bitcoins were traded on the 18th of December. This indicator was flashing a warning sign that the market was running out of momentum. There were very few buyers willing to “step up to the plate” and purchase bitcoin as these lofty levels. Consequently, the price began to roll over to the downside. So far, bitcoin has been unable to generate enough strength to revisit the 19K level. This is a perfect example of why volume is such an important tool when trading bitcoin, or any asset class for that matter.
The huge decline on 12.22.2017 was not confirmed by record volume. Most likely, this day marked a short-term bottom in bitcoin; maybe even a long-term bottom.
Volume is very similar to moving averages in terms of producing false signals. However, this strategy certainly has a useful purpose. Volume should not be ignored.
#3 Pay Attention to Relative Strength
The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. The oscillator fluctuates between 0 and 100. RSI is a fairly popular indicator which can be found on many financial websites.
Typically, traders use RSI to determine if a market is overbought or oversold. The general belief is that a market becomes overbought when RSI exceeds 70. Conversely, a market becomes oversold when RSI drops below 30. This particular strategy doesn’t work very well in the real world. Markets can remain overbought or oversold for extended periods of time. As a result, RSI tends to generate many false signals.
A more appropriate way to apply RSI is to use it as a confirmation indicator. For example, if bitcoin is making a new high, RSI should also be making a new high in order to confirm the strength of bitcoin’s breakout into new territory.
Using RSI to Confirm a Breakout
|Date||Breakout Level||RSI Reading||Confirmation|
|10.12.2017||4928||87.42||Breakout was confirmed|
|10.16.2017||5860||88.77||Breakout was confirmed|
|12.18.2017||17948||87.14||Breakout was not confirmed|
|12.22.2017||14322||63.51||Breakout was not confirmed|
The table above displays the bullish breakout on 10.12.2017 and 10.16.2017. Both breakouts were confirmed by a new high in RSI. However, the breakout on 12.18.2017 was not confirmed by the RSI. This turned out to be a false breakout, which is precisely what RSI was forecasting. The bearish breakout on 12.22.2017 was also not confirmed by RSI. Once again, this turned out to be a false breakout. Please review chart #3 for more information.