We’ll start a new series of posts to help you go from a rookie to a proficient trader in investing if you put the time and effort.
What is investing?
There are multiple investment theories. Here, we’ll approach 3 of them which are presented in “A random walk down wall street”: the firm foundation theory, castle-in-the-air theory and efficient market theory.
These 3 theories are mutually exclusive and will help us understand how to invest or trade cryptocurrencies.
Firm Foundation Theory
This theory argues that: each investment instrument, be it a common stock or piece of real estate, has a firm anchor. This anchor is something called intrinsic value.
What this implies is, that assets have some value and that eventually market participants will perceive it. This means that if you buy an asset that is undervalued, eventually you’ll be able to sell it for its real value and you’ll realize profits from it.
This investing theory is attributed to 2 authors S. Eliot Guild and John B. Williams. For more information you can read The Theory of Investment Value by Williams.
Castle in the Air Theory
As presented by Burton on A random walk down wallstreet, castle in the air theory concentrates on psychic values. This theory was presented by John Maynard Keynes, a famous economist in 1936.
It was his opinion that investors should analyze how the crowd of investors is likely to behave in the future. Also, how during periods of optimism they tend to build their hopes into castles in the air.
Keynes practiced what he preached. He used to trade from his bed for half an hour each morning.
In comparison, floor traders would go to their offices every day to analyze the market and trade. This method earned Keynes a fortune.
Keynes implied that people can’t predict with accuracy the discounted values of the company.
He stated that people are basically buying things in order to sell it to other “suckers” who are willing to pay more for it. Due to this you should estimate what the common traders will think about a specific asset: then from there determine your position and sell it when the time is right.
Knowing this, most cryptos are castles in the air. The decentralization or the applications of crypto have not come to fruition.
Bitcoin is a good method to transfer huge amount of money at low cost but its still far from major recognition. Ethereum has only dapps that do not provide any real value, the few gambling dapps that exist has a few handful of users and do not provide any valuable returns. A good example of this is Etheroll (DICE).
For more information you can refer to his book on General Theory of Employment, Interest and Money.
Efficient Market Theory
There are 3 variants of the efficient market theory, which is an attempt to explain why securities, stocks or trading instruments behave the way they do:
- Weak-form EMH: The stock price fully reflect all historical information including past returns. Thus investors would gain little from technical analysis.
- Semi-strong EMH: The stock price fully reflect all historical information including past returns and ALL current publicly available information. Thus investors would gain little from technical analysis.
- Strong-form EMH: The stock price full reflect all historical information including past returns, currently publicly available information and insider information. Investors therefore can’t benefit from technical analysis.
This theory emphasizes in the fact that no one can actually determine the correct price of a stock, so buying an index to expose yourself into the given market would yield better returns than investing in an actively managed fund where there’s a manager that trades actively the assets of the fund.
Other people argue that Crypto has some value and that it will change the world. Frankly, we do not care about it, and it might or might not but we want to become traders that take advantage of current cryptocurrency volatility.
You might want to drink the kool-aid but we suggest to not do it as you should never “marry” an investment. This is how investing should be.
Drinking the kool-aid might make you a follower, a cult, one of those bitcoin maximalists that won’t sell when the time comes and its needed in order to avoid being underwater.
Technical Analysis in Investing
Technical analysis is the most common method that users apply to trade. It involves the use of trading charts that portrait price against time, usually in the form of candlesticks, and imply that there are some kind of trend that can be identified and can make predictions of it.
Technical analysis has 2 core principles:
- All information about a security or trading instrument is automatically reflected in the instrument’s past market prices.
- Prices tend to move in trends.
Fair warning: some academia users and the Efficient Market Theory imply that most price of stocks or assets revolves around a random walk. What’s this? that they are “almost” random and no no one can predict them with accuracy in order to obtain value from it in the long run.
The other side of the coin is that a lot of traders use algorithms based on technical analysis and mathematical methods. Such algorithms involve backtesting and statistical methods which help identify strategies that were valid in the past and try to determine if they’ll work in the future.
They use techniques in order to craft an edge against other traders in the market and that’s what we want you to learn and use in order to become a profitable trader.