Fundamentally right — technically wrong or vice versa
Technical and fundamental analysis for trading
When you’re looking into trading the first way of doing things is just to go by intuition. And while some successful traders seem to have golden hands, most of the time they spent a lot of time on researching and analysing assets before investing.
“It takes a lot of effort to make something look effortless” — Ben Mitchell
There are two different approaches to analysing the price (or predicting the future price) of assets: fundamental and technical analysis.
Fundamental analysis is a more pragmatic and rational way of approaching evaluation of an asset. The first assumption of fundamental analysis is that prices are not always correct, consequently by identifying undervalued assets, you can make money. This is due to the second assumption that prices will eventually correct themselves. As you might imagine, this kind of analysis is more suited for people looking to invest long-term as you’d have to wait for prices to correct. In crypto, one could classify traders using this approach as HODLers who deeply believe in the future of the assets they’ve invested in. Especially in bitcoin, we can find many of those.
Below you can find some metrics that are used in fundamental analysis.
The Price/Earnings-ratio (P/E-ratio) is calculated by dividing the current price of an asset by the earning/asset. Usually, this metric is applied to stocks, but with PoS blockchains, you could also use it similarly to calculate how much you earn on holding a certain token.
When investors talk about the valuation of a company they often refer to the price/earnings ratio. Fast-growing companies often have a high P/E ratio, because people expect them to continue growing and are therefore more willing to spend a higher amount on purchasing a stake in their success.
The Price/Book ratio (P/B ratio) is calculated by dividing a company’s stock (or a digital equivalent of a stake in the enterprise) price by the book value per stock (total assets — liabilities). A low P/B ratio can be indicative for an undervalued asset.
This metric is pretty self-explanatory and simply reflects the number of sales a company has done in a certain period of time. More important than the number itself is the direction it is going. Are revenues growing or have sales been going down?
The sector in which a company is doing business in can heavily influence how well they will be doing. For example, utilities and consumer staples tend to perform better than technology during an economic downturn.
For cryptocurrencies, it is hard to say if there is really much connection to what’s going on in the rest of the economy. However, they’re often said to be a hedge against risk and we’ve clearly seen an increased use of crypto in countries with high inflation rates.
The big picture
Consider where we are in the economic circle, are we at the beginning, middle or end of a recession/boom? It might not change what you will need to do, but it could affect your choices.
Probably one of the first associations you have with the profession of a trader is looking at charts and hitting buy & sell. Traders use these charts to conduct technical analysis which involves analysing price charts for patterns to predict further movements. Some things analysts look out for in charts are:
Is the price moving up or down and how long has it been following a certain trend?
Many will only buy assets that are in an upward trend and not even consider assets that have been in a downward trend for a long period of time.
The trading volume can be another indicator of how strong the prevailing trend is. If the volume is decreasing during an upward price trend, this could indicate a reversal of the trend.
If you’ve ever set eyes on a trading view chart, you might have already seen that there is a huge variety of different indicators that you can add to your chart. Here are just a few, but the more serious you are about your trading, the more different indicators you might want to consider.
The Moving Average (MA) is one of the lines you can draw in on most trading platforms in your charts these days. The moving average simply shows the average price of an asset over a certain period of time, for instance, the 10-day moving average projects the average price for 10 days. Technicians like to buy when the moving average is in an uptrend and prices are slightly pulling back which allows for a good entry point.
On Balance Volume
OBV shows an accumulation of total volume of a traded asset over a certain time. There are three rules when calculating the OBV:
If closing price today > yesterday = previous OBV + today’s Volume
If closing price today < yesterday = Previous OBV — today’s Volume
If closing price today = yesterday OBV stays the same
This indicator is based on the distinction between institutional investors and retail investors. The idea behind is that when institutions start buying into an asset that retail investors are selling, prices might first remain the same but volume would increase (as institutional investors have higher liquidity). At some point, the higher volume would drive the prices up. This is when institutions start selling and smaller investors jump on to the bandwagon and buy-in.
Analysts use the OBV to track large, institutional investors and in trying to identify divergence between volume and price. Whenever you are using the OBV be careful, as it can be highly diffused by a spike in volume on a single day.
Relative strength index (RSI)
The RSI is an indicator between 0 and 100 that measures the speed and strength of price movements by comparing the current price to past price performance. Traditionally assets will be considered overbought when the RSI is above 70 and oversold when RSI will fall below 30. The RSI helps identify support and resistance levels, potential entry and exit signals and can indicate a reversal of trends when diverging from the price chart.
A few closing words: This article is meant as an introduction to the concepts of fundamental and technical analysis. By no means, is it a complete coverage of all existing metrics for both of these.
As you can imagine many crypto-traders are using technical analysis to decide on when to buy or sell a certain asset. However, you can also go for a combination of fundamental and technical analysis to get a clearer picture.
At the end of the day, no one will be able to predict the future with certainty. A whale could suddenly decide to sell driving the price down or some partnership is announced that induces FOMO and a spike in price that no one could foresee. Therefore, never forget to manage your risk and only invest what you’re willing to lose — as boring as it may sound 😉