A Review of NVT Signal, Difficulty Ribbon, and Bitcoin Volatility
Some more tools you can adopt in your crypto trading analysis
Technical indicators have been helping traders and investors to analyze the past and predict future price trends and patterns, they are popular among traditional financial market participants, crypto traders have been taking advantage of all these conventional tools to make better trade decisions. Previously, we’ve reviewed some of the key technical indicators and highlighted the usage of the Sharpe ratio. This time we will go through some of the indicators that are tailored for cryptocurrency trading.
First introduced by renowned crypto analyst Willy Woo in 2017, later modified by tech expert Dmitry Kalichkin in 2018, NVT Signal analyzes the crypto price performance using blockchain data. The calculation of NVT Signal is the network value divided by the 90-day moving average of the daily transaction value. NVT Signal is widely considered as an effective trading indicator that tailored for crypto trading.
The rationale behind NVT Signal was borrowed from the P/E ratio. In the equities markets, analysts can examine a company’s value by using the price-to-earnings ratio. Since bitcoin is essentially a payment and store of the value network, in a sense that the capital flows of the network could be a representation of “company earnings”.
Figure 1: BTCUSD with NVT Signal
In the case of bitcoin, when the NVT Signal is above 150, it’s considered overbought. When the NVT Signal is below 45, it indicates oversold. Figure 1 shows the daily BTCUSD performance since April 2017. In Jul 2017 and Feb 2018, the NVT Signal caught the market bottom and touched the 45 levels (yellow circles), that followed by a significant price rebound.
On the other hand, the NVT Signal jumped into the area above 150 multiple times (teal vertical lines), and in many cases, the Signal successfully indicated the tops. Combining with trend analysis (thick blue line), traders will able to make a better decision when it comes to exiting a trade.
Bitcoin Difficulty Ribbon
Difficulty Ribbon is another indicator developed by Willy Woo, it contains the simple moving averages on bitcoin mining difficulty and their rate of changes.
Generally speaking, when new bitcoins are mined, miners usually sell some of their mined new bitcoins to pay for the production costs, these actions could create pressure on crypto prices.
According to Woo’s theory, the weakest miners sell more of their coins to remain operational. When it becomes unsustainable, they capitulate, hashing power and network difficulty reduces (ribbon compression), leaving only the strong, who sell less leaving more room for more bullish price action.
Therefore, when the ribbon compresses, for example, the purple circles in figure 2, that could indicate an opportunity to enter a trade.
Figure 2: BTCUSD with Difficulty Ribbon
Volatility refers to the amount of risk related to the rate of changes in a security’s value, in this case, bitcoin. Greater volatility means that bitcoin’s value can change dramatically over a short period in either direction, which also means more people will want to limit their exposure to it. A lower volatility means that a security’s value does not fluctuate intensely and tends to be steadier, and the cost of converting into and out of bitcoin will decrease as well.
The volatility here refers to realized volatility, which calculated based on historical data, providing the volatility that was experienced in an asset over a given timeframe. This has its limitation as realized estimates can only be a rough guideline for expected future volatility, they are not nearly as thorough as implied volatility estimates.
Figure 3: 30-Day BTCUSD Volatility (Green) vs. BTCUSD (Blue) YTD
The rising penetration of cryptocurrency trading in the traditional financial markets has been leading to the sophistication of price analysis, the NVT Signal, Difficulty Ribbon, and volatility index are some good examples of bringing conventional market analysis concepts into the crypto space, they give traders and investors a more complete picture when it comes to making trade decisions.
Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involves significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.
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