Indicators for bitcoin trading | A guide for traders
I am being asked by a few people these days what kind of indicators I use to trade bitcoin. So I thought I’d give it a shot and put it to paper.
It is important to understand: this is my personal opinion and none of this is financial advice. This isn’t my professional opinion either. If you read it, you should treat it like any other piece of information. Verify yourself, do your own research, and never trade based on someone else’s opinion. Also, I have been trading financial markets for over 20 years, so there are quite a few things that would be “muscle memory” for me, which you cannot build by simply reading a trading manual and which I cannot put into an overview of trading indicators either. It is usually built with experience and that usually means losing money. Be sure you understand all of this.
Alright, let’s get started.
In order to understand how I use the indicators I put down below, it is important to understand what kind of trading I use them for. I do not trade extremely short-term periods (like hours or even just days) in general. There can be exceptions to that rule, but most of my trading takes place over a few days and up to a few months if a position is right. Also note that all of what I write here may be transferable to traditional markets, but it is (in my opinion) much more useful in bitcoin trading. I am explicitly excluding altcoins here as well.
Furthermore, my basic premise is that I can benefit from two main behavioural trades:
- Building Momentum: In this case, I identify a trend or a “force” that is likely to get stronger over the next little while. It may already have found fans/positions may already have been built, but we are by no means overextended in any way and there is, generally, a lot of skepticism regarding that specific force left in the market. This is frequently called “climbing the wall of worries”. It means that markets are pushing in a certain direction, while that direction is not entirely clear to everyone yet and most people have “worries” so they are not fully exposed. That means they have room to add to positions. The culmination of this trade is typically a “blow off top” if it is a long trade or “capitulation” if it is a short trade. These trades can last for a few days, but often last for weeks or months. The key to this trade is identifying the beginning and the end of these longer-lasting moves (which also implies the understanding that anything in between is neither).
- Irrational Exuberance: This is a trade where the basic premise is that any kind of overextension is bad/wrong. The idea is that once everyone is positioned in a certain way, there is hardly much more room for it to go further in that direction. In a way, it is the opposite of the first trade listed here, but it is generally much more short term and can be a very helpful addition for position management in a momentum trade. Practically, I feel uncomfortable when a vast majority of market participants is of the same opinion as myself. It means I am positioned with the crowd and likely prone to a squeeze due to “natural” market forces or even a sinister market maker who sees an opportunity. Usually, this trade (where I take a position that is against the majority) will resolve in either a long squeeze (prices fall strongly as leveraged long positions are stoped out, causing more stops to be triggered, causing the price to fall further) or a short squeeze (prices rise strongly as leveraged short positions are stoped out, causing more stops to be triggered, causing the price to rise further). Generally speaking, at the end of this trade, most sentiment indicators are back to neutral.
So if you were to summarize the above, you could say I trade for longer-term (months+) swings in general (trade 1), but I will reduce or even flip my positions for short periods of time (trade 2) in between.
I note that this still does not cover position size management and risk management which is an entirely different animal and the key to long-term survival.
So let’s look at the indicators I mainly use for my style of trading.
Building Momentum Trade
This is the more difficult one of the two trades to correctly identify and there is no single indicator one can rely on to correctly call this. For the purpose of this overview, I will assume that the trade identified is a LONG trade (ie buying a position & making money if prices rise), but using the opposite of the described observations would be just as applicable to a SHORT trade.
a) Identify the beginning
The beginning of a building momentum LONG trade is, by definition, the certain end of a consolidation or a crash. The goal is to identify what could be the beginning of a new bull market.
Higher lows & higher highs
The first indicator that signals we are changing market structure from neutral/bearish to bullish is the emergence of higher lows on a chart, followed by higher highs. It is important that both conditions are met. If you look at bitcoin price action around the end of 2018, you could clearly identify that chart making higher lows (on every new drawdown, the price did not go lower than on its depest drawdown in the period and almost every new low is higher than the previous one). Note that this is not a race, we are waiting for significant lows to show. Not every move is a low or a high.
Remember we are trying to understand if price has bottomed and if market structure is changing. There is NO rush here. You do not need to jump into any kind of trade and you can wait and see what actually happens. Once market structure shifts, it will last long enough for people to make money even without catching the low. Trying to guess the bottom is called “knife catching” for a reason as it seldom ends well.
The only thing you were able to establish in the first two lows here was “higher lows”. What you did not get were “higher highs”. For the way I trade to be successful, you need to see both. I can totally understand the lure of jumping into a trade early and catching the break out at the end of this chart and I will even try this with small amounts of money, but that trade is a punt and these kind of trades, in my personal experience, do not generate meaningful returns over the long term. Once the break out happens though, you know that you will have a higher high as well, so the second condition is met.
It is still a question of market timing here, which is whether one buys the break out or whether one waits for the re-test. There is no easy answer to that, but if you look at how this move continued, you can see that both work.
If you bought the break out you were able to make a lot of money, if you waited for a re-test long enough, you entered a long term position in a much more stable situation, but you had to wait a long time and practically missed a mini bull run and a mini bear run in the process.
The second indicator that signals to me that we may have changed market structure is the general “drift” of the first consolidation period after a new higher high. In my experience, if market structure has shifted from bearish to bullish, consolidation periods will exhibit a slight upwards drift in themselves. Look at the two consolidations after the break out we just looked at.
In both of these you can see that, after a massive move to the upside, price consolidated, but kept a structure of higher lows and higher highs going even during these consolidation. If market structure has not changed, you are reasonably likely to instead see a “head and shoulders” pattern emerge or something similar, as it did a bit later (below).
Macro factors improved
This is the most difficult aspect in identifying the beginning of a sustainable momentum trade. To put it simply “something needs to have changed”. In my experience the sheer longer term exhaustion of sellers and a capitulation that goes along with that is not enough to consitute a new bullish market structure. There needs to be a force that makes it likely that the asset you look at is going to keep climbing over a longer period. Again, to assess this, we have a lot of time. The momentum trade is not about trying to snipe tops or catch the bottom, it is about establishing whether there will be a longer term upmove coming.
In the case of bitcoin, which is a risky, financial asset that is searching for a role, but is most likely to emerge into a pure gambling asset or become closer and closer to being a disinflationary reserve asset, the key macro variables we can look at is global or (even just US) money supply (which simply presses all assets upwards as it increases), as well as Willy Woo’s bitcoin NVT ratio, which is an attempt to make a bitcoin PE ratio but using transaction activity.
Looking at money supply, I am sure that, if you look at this chart, you can see that “something changed” recently:
When the Fed expands money supply as agressively as it did in 2020, you know that a new era for asset prices has begun. As a matter of fact, a similar move (not as easy to see due to the fact it is not a log chart) had taken place at the time bitcoin was born.
On the NVT-ratio side, things are a bit easier, as Willy has a website (woobull.com) where you can even find a “buy/sell” indicator, which makes the whole idea quite self explanatory.
Additionally, if you are very involved in crypto, you can look for new trends such as ICOs or DeFi (total value locked up was a great indicator for a new bull run) to add to your observations. Having a new use case that people start using in droves is usually very supportive for price, regardless of what you may think of that use case.
This is really all there is to identifying the beginning of a bitcoin momentum trade in my view. There are additional things that might help, but they are very much related to “muscle memory” and I have a hard time spelling them out. I do think the above is sufficient in identifying the beginning of a bitcoin momentum trade though.
b) Identify the end
Luckily, identifying the end of a momentum trade is easier (I think) than identifying its beginning. You are looking for capitulation, frequently called “blow off top” in the case of long capitulation. Remember, we are looking at a long trade here, but anything written is applicable to a short trade as well, it is just the opposite. What you are looking for is the moment when everyone who was not invested before “throws in the towel” and buys into the move for fear of missing out (FOMO).
In bitcoin, a “blow off top” often occurs at the end of a parabolic advance. This is a move up where you can draw a “parabola” to connect the lows of a chart. Once that parabola gets broken, you are usually at the end of a medium-term move (not necessarily a bull market).
The next thing you want to see is whether the next move to the upside manages to establish a higher high again. If that is the case, the parabola that just broke probably does not mark the end of the bull market yet. But if it does not, it is very likely your best moment to exit the momentum trade that you hopefully have on at this point.
Finally, capitulations, both long and short occur at extremely high volumes (see the green and red bars below the chart above).
This is enough to know that you probably need to exit your trade. There may not be a bear market forming, but you are likely to at least see consolidation and neutral market structure for some time.
Additionally, basically as a throw-in, in case you are dealing with a bubble, I have frequently observed that bubbles tend to break an established upwards trend channel to the upside and then rise by 100% in very short order before they collapse. This is what I call the “bubble roof” and it held true both for bitcoin in 2017 as well as the Nasdaq in 2000. When you see this kind of a move on a longer period (again, remember I do not trade hours or just a day or so), then usually it is best to run.
This completes the trade that I call “building momentum”. It is the main compass to my trading and it determines whether I look for long setups or short setups. I try to avoid shorting in a bull market and I try to avoid longing in a bear market. This means I never catch the bottom and I never sell at the absolute top. But it meant that I was long bitcoin from April 2017 to January 2018, short bitcoin from March 2018 to March 2019, and long again since July 2020 in my trading positions. It is absolutely sufficient to generate strong returns and it causes much less stress than trying to catch shorter-term set-ups.
Irrational Exuberance Trade
As stated above, this trade is much more short term in nature and I use it mainly as an addition to my longer term trading positions which are always driven by momentum. The trade is a great addition because it will help you live with your fear and greed monkey that will try to make you suffer with any trade whether it works well or poorly. It is a very good feeling (and one that I’d argue is important to be successful) to take profits along a trade and this one is nicely suited for it.
The irrational exuberance trade seeks to identify overextensions which are not sustainable and will correct. It, therefore, takes a position that is at the opposite side of what most people are currently positioned for, whenever that positioning becomes extreme. The good news is — there are only two indicators that are necessary for this trade.
Bitcoin leverage funding rates
People who trade bitcoin on leverage, using perpetual futures (aka those traders most likely to be squeezed in either direction) pay a fee to the market maker which is used to “balance” the positions between longs and shorts. Simply put, there are financing costs associated with open positions in any asset and “usually”, this is taken care of by futures being set for a given date (like expiring end of December). This way, the financing costs will be implicitly included in the price premium or discount of the future to the current price of the asset (spot). When a future is “perpetual”, ie it has no end date, this has to be taken care of differently so that spot price and future price remain in balance.
So exchanges offering these products charge a funding cost to them regularly to ensure futures are matching current price. It is important to note that, if longs and shorts on a given platform match perfectly (ie there is just as much “prerssure” behind either side — nobody pays much more or less than current spot), there are zero costs. If this tips to the shorts, financing will be charged to short positions. If the opposite is true, longs have to pay. If you look up funding costs, a positive rate means “longs pay”, while a negative rate means “shorts pay”. Also note that this is not an exchange fee. Holders literally pay each other so that there is an incentive to open a position in the side which is underrepresented.
There is a fantastic site that allows you to track current funding costs across exchanges — bybt.com.
In my experience, for bitcoin, anything above 0.01% is beginning to be overly optimistic (ie the consequence would be to close longs), anything above 0.05% is extreme (ie you could consider shorting). Anything negative is overly pessimistic and anything more negative than -0.05% screams buy in this approach. When funding is at 0.01% you can generally disregard the indicator — it is unlikely to help.
Funding rates are often a bit slow to show a change, so in addition it is helpful to look at these two indicators:
The first is the premium of bitcoin priced in tether (average of binance and bitfinex) over USD (Bitstamp). If it is negative, tether can easily manipulate price up with prints. When positive that is harder as they would risk the peg. When BTCUSDT is higher than BTCUSD, all tether accomplishes by printing and buying BTC with USDT is for USDT to lose value against the real dollar. That would be suicide.
The second is the leveraged premium (average of bybit and bitmex perpetual price) over USD (Bitstamp). If it is negative people are bearish and funding likely comes down and if it is positive, there is still leverage in the system that could get cleared with a dump.
The tickers I use in tradingview are:
- Tether premium: (BINANCE:BTCUSDT+BITFINEX:BTCUSD)/2-BITSTAMP:BTCUSD
- Leveraged $BTC premium: (BYBIT:BTCUSD+BITMEX:XBTUSD)/2-BITSTAMP:BTCUSD
As CME futures take a more prominent role, you can also look at the positioning of “leveraged funds” in the regular commitment of traders report. Though it is slower moving. It can be found here.
Bitcoin future premium & discount
An additional indicator is looking at the bitcoin futures curve. Futures (non-perpetual ones) generally expire at the end of each calendar quarter and they trade at a premium or discount to current spot price.
When futures trade in premium, meaning that people anticipate a higher bitcoin price 3 months or 6 months down the line, that is called “contango”. When they are in discount, it is called “backwardation”.
A “normal” level for bitcoin is to be in contango by about 0.5–1.5% looking out 3 months. If contango gets stronger than that, it is an indicator that suggests people are too optimistic. The same holds true for backwardation with the extend of a discount.
Whenever these indicators align, an irrational exhuberace trade would mean taking the opposite stance. Ie if people are overly Bullish the trade is short and if people are overly Bearish, the trade is long. These trades are short term in nature and future funding and premium can revert very, very quickly to “normal”. So this requires very active monitoring. Usually this does not last for more than 3–4 days overall at an absolute maximum.
A note for the future: when interest rates rise, that means financing costs rise, so the levels described here might need to be adjusted by the current interest rate.
The last input here is something I have had to start paying attention to more recently. Whatever you think about tether and whether it is legit or not (IMO it is a giant scam), it is undeniable that their prints and especially their sends to exchanges (foremost binance) move prices. If you think you have the perfect short set up, but then tether prints and sends to binance — in my experience you GTFO of the trade. I won’t say as far as I “blindly long” tether prints, but its not exactly a lie.
There are obviously a number of other indicators and chart formations that can help with trading, but the ones I have listed here are those that I look to most frequently and that guide most of my trading positions in bitcoin.
The way I personally put it together for my trading is summarized in this matrix:
I want to stress again — all of the above is personal opinion. None of it is financial or any other type of advice.
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Lastly, the all important disclaimer: this is my personal opinion, not my professional advice. Most of all this is not investment advice in any way. Crypto assets can fluctuate widely in value and all of your capital can be lost. I have a 50/50 chance of being right. Any negative views expressed, if any, are solely aimed at the token in question, never at the development teams behind them for which I have utmost respect (if they are sincere).