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The Bears are Weak, Technically Speaking

The Bears are Weak, Technically Speaking

When analyzing a potential investment, most investors are familiar with fundamental analysis, but many overlook technical analysis. It is easy to think about an investment’s intrinsic value, assessing a company’s financial position for a stock, or the macroeconomic landscape or the change in utility for a commodity or currency, but there are times we can gain critical insight from the information derived from charts.

Technical analysis is the discipline of evaluating an investment through statistical calculations of past market data to forecast the direction of prices. Technical analysis is often used to predict price movements over a shorter timeframe than fundamental analysis.

For a cryptocurrency like Bitcoin, for example, an investor may believe there is a strong fundamental case for Bitcoin to be valued at an exponentially higher price than its current trading range. This belief could be based on the attractive intrinsic properties of Bitcoin (being censorship resistant, scarce, trustless, permissionless, etc.), but it is difficult to confidently predict the timeframe for a significant price movement. While the use case may be undeniable, Bitcoin’s price in USD is a factor of supply and demand, and there are certain catalysts that would contribute to the price moving towards Bitcoin’s perceived fundamental value. These catalysts could include things like clarity on regulatory and tax treatment for various countries or Bitcoin becoming accessible, or more easily accessible, to various segments of the retail and institutional markets. There isn’t a clear timeline on these events, so an investor may turn to technical analysis to predict price movements on the short and intermediate timeframes.

While we don’t need the assistance of moving averages or other trend indicators to tell us the price of Bitcoin has been in a downtrend since its peak last November, could technical analysis reveal a changing tide? Looking at the chart below, three lines of declining price resistance have been added to the price action.

What story is this telling us? From November - February, sellers were willing to sell Bitcoin at lower and lower prices, while buyers were unwilling to pay higher prices. The drop was steep. Prices then ranged for a couple months before starting another decline from April - August. During this period, the slope of the resistance line is not as steep. In the most recent period, from August - October, we see an even less steep resistance line, followed by price eventually breaking above it near the end of October.

This could make one wonder if the bear market is losing steam. Sellers aren’t seemingly as willing to accept lower prices, and buyers are more willing to accept prices in the current price range. Before a technical analyst draws a conclusion that the momentum is changing, they’d likely look for confirmation from additional technical analysis, specifically using a leading indicator.

One of the most popular and reputable leading momentum indicators is the relative strength index (RSI). The RSI is an oscillator, meaning the indicator has high and low bands (30 and 70 are the default values for RSI) which are used to indicate whether we are in overbought or oversold territory. The RSI is a calculation of the average upward price movements relative to the average downward price movements.

Divergence between the RSI and the direction of price action is generally seen as a critical signal that a reversal could be imminent. In a downtrend, technical analysts will look for a bullish divergence. A bullish divergence can be spotted when the RSI shows us an oversold condition (indicator moves below 30) followed by higher lows while price is making lower lows over the same period. Looking at the chart below, we see just that from the end of August to the end of September.

The RSI, starting below the 30 threshold, makes two higher lows. When we look at price action, we see a divergence where the price makes lower lows. This is a clear signal that the sellers are losing strength. The downward momentum is weakening, confirming our earlier observation

While major catalysts are tough to predict, we could look to technical analysis for direction. A case can be made that this Bitcoin bear market is on its last legs and a reversal is coming soon or has already begun. If you believe Bitcoin is trading at a significant discount to its intrinsic value, why not watch the charts to find attractive points to enter a trade or add to an existing position?