In the world of investing, there are generally two ways to analyze assets with a tradeable price: technical analysis and fundamental analysis. These two disciplines are what traders and investors use to forecast asset prices in the short, medium, and long term. Let’s explore both!
In the world of stocks, fundamental analysis evaluates them based on external and internal factors such as the overall economy, the financial health of the company, the political and regulatory environment, and the cost of goods. At its core, fundamental analysis assumes that a stock’s fundamental data reflects a company’s true value - this is what others call intrinsic value.
However, the case is different with cryptocurrencies since they do not have financial reports and pertinent data to help analysts determine their intrinsic value. With this, investors look at three main types of data to fundamentally analyze a cryptocurrency:
Since most cryptocurrencies are built on public blockchains, transaction data related to a cryptocurrency is available to view publicly 24/7 in real-time. This can include data portraying movements, transfers, the age of coins, and the number of holders.
On-chain metrics provide investors with a new way of applying fundamental analysis to cryptocurrencies. One simple example of an on-chain metric is the Number of Active Addresses Metric. This metric shows the number of wallets on the bitcoin blockchain that are currently holding some bitcoin. The higher the line, the more bitcoin holders there are.
The world of on-chain metrics is vast and can cover simple data up to complex data and can even be a mix of both. However, it's important to note that on-chain metrics only provide you with the data, and it's up to you, the investor, how you want to interpret it and devise an investing strategy based on that.
Cryptocurrencies also have quantitative values that help give investors an idea of their size and activity. Generally, the three most common financial metrics are Market Capitalization, Trading Volume, and Circulating Supply.
These refer to the different external factors that are related to a certain cryptocurrency. Views on these factors are highly subjective and can vary depending on the person analyzing them. Some examples are a cryptocurrency’s whitepaper, competition, and founding team.
Unlike fundamental analysis, technical analysis focuses on price movements and trends rather than looking at financial or socio-economic factors. Technical analysis is a discipline used by other investors to value an asset based on its chart, with the help of other indicators and candlesticks. At its core, technical analysis assumes that an asset’s fundamentals, or intrinsic value, are completely factored into its market value. This discipline is widely used by cryptocurrency traders, especially for shorter and medium time frames.
In applying technical analysis, here are the basic concepts and tools you need to get started:
A candlestick is a type of price chart that shows the “high”, “low”, opening and closing price of an asset for a specific timeframe. Candlesticks immediately provide the viewer with information on a cryptocurrency’s movement.
Let’s take this candlestick, for example. According to this candlestick, the price of Bitcoin reached a high of $10,000 and a low of $9,000 for the day. Bitcoin also opened at $9,200 and closed at $9,800.
Price movements of cryptocurrencies can be viewed in different timeframes, such as minutes, hourly, daily, weekly, and monthly. Generally, candlesticks will represent the timeframe you choose on your chart. For example, if you choose to view a Daily timeframe, one candlestick will represent one day. If you choose to view a Weekly timeframe, one candlestick will represent one week.
If you recall the terms “supply and demand” in economics, then support and resistance is essentially the same concept. Price rise when demand is greater than supply, and price falls when supply is greater than demand. However, prices can’t just rise or fall forever. At some point, supply would have to be greater than demand and vice versa. An area or level of support is where there is heavy demand which causes price to stop or even reverse in that area into an uptrend. An area or level of resistance, on the other hand, is where there is strong supply which causes price to stop or even reverse in that area into a downtrend.
In statistics, the mean refers to the average of a collection of numbers, in this case, prices. So, a moving average in technical analysis means a constantly moving arithmetic mean that adjusts based on the most recent prices. If the price of Bitcoin in the following 10 days, for example, continues upwards from $1,000 to $1,100, the 10-day moving average would rise as well. Since the moving averages move along with prices, they are lagging indicators and can be useful in determining possible support and resistances. The longer-term the moving average is, the stronger its signals in determining trends become. The market convention is to use up to 200 days as the moving average length.
Scroll left to view full table
With these two disciplines, different investors value cryptocurrencies differently, either using Fundamental or Technical Analysis or a combination of both. For example, Investor A says that fundamentally, cryptocurrency XYZ is worth $5, while Investor B says technically it's worth $8, but Investor C, who uses both fundamental and technical analysis, says it’s worth $12.
These different valuations will cause cryptocurrency XYZ to change hands at different prices - due to some people thinking they're buying a cryptocurrency that’s undervalued, or overvalued based on their own analyses. This is where volatility comes into play. Volatility is the tendency for an asset to increase or decrease in value in a short period of time.
The cryptocurrency markets are volatile and sometimes unpredictable. To keep you safe, you can apply some practices and mindsets to help you in your investing journey - more on that in the next module!