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Fundamental Analysis in Crypto 101
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Cryptocurrencies are volatile assets and crypto trading is associated with high risks, so it’s easy for novice traders to lose money on the crypto market if they don’t understand the rationale behind the digital assets’ price fluctuations. To better understand how the crypto market works one should familiarize themselves with fundamental analysis.
What is fundamental analysis?
Fundamental analysis is the evaluation of various factors that affect the price dynamics of crypto assets. Fundamental analysis includes evaluating a range of factors from a users’ social activity to economic and political market conditions.
All markets are unpredictable and the cryptocurrency market is not an exception; but, fundamental analysis helps to sort out the chaos and understand what scenarios are most likely to develop in the future based on historical data. Apart from market factors, one should always evaluate a crypto project themselves before investing. For example, if you are to invest on the stock market, a fundamental analysis would be a study of a company’s performance and the health of the corresponding industry. For cryptocurrencies, fundamental analysis is similar in which an investor should evaluate a project’s integrity and forecast. But it’s not always that simple, and in this article we will continue to explain why.
As a market matures it can become immune to certain factors. A recent prime example was the staggering stock market and cryptocurrency crash during the first wave of the COVID-19 pandemic back in March of 2020. However, during the second wave markets reacted contrarily and the securities and cryptocurrencies markets entered our current bull run.
In short, you should evaluate not only the factors themselves but also the historical reactions of the market. The market is a community of traders and investors and has its own psychology. With fundamental analysis, it’s not only the factor itself which plays the most important role, but how the market participants’ react to it.
The difference between the fundamental and technical analysis
Technical analysis focuses solely on the market indicators: support and resistance levels, overbought and oversold levels, upward and downward trends, and others. Technical analysis does not take into account the activity of the community, developers, project/company updates, hardforks, and a number of other important fundamental factors.
In other words, technical analysis is an important short-term consideration and useful for traders, whereas fundamental analysis is necessary for investors who are focused on the longer time scales. Meanwhile, investors use behavioral analysis to identify short and medium-term market trends.
What causes cryptocurrency price movements
There are numerous factors and depending on their nature, each of them can affect the dynamics of certain cryptocurrencies in different ways. Let’s consider the main types of factors affecting the trends of the crypto market. There are local and global factors and external and internal factors when categorized according to the nature of their impact on the market.
Local factors affect only the crypto market or a specific group of cryptocurrencies, such as altcoins or DeFi tokens. Other cryptocurrencies will be affected only indirectly, for example, by investors’ assets flowing into tokens of decentralized platforms, as happened during the DeFi rush.
These factors take into account the social, economic, and political situation in the world. The pandemic again perfectly illustrates the impact of the global financial market: after the WHO COVID announcement, investors began converting their assets into currency en masse, causing stock and cryptocurrency prices to plummet and fiat currencies to rise.
Internal factors include events related to individual cryptocurrencies: project news, upgrades, the launch of a mainnet, hardforks and more. News covered by the media can encourage investors to pay attention to the project, even when the cryptocurrency market is stagnant or undergoes a correction.
These factors are not directly related to the individual platform and blockchain but indirectly influence its market dynamics. External factors include large traditional companies’ attention to cryptocurrencies. Bitcoin and other cryptocurrencies began to skyrocket after PayPal’s announcement about adding an opportunity to purchase bitcoin right within their app.
Analysis works best when factors are evaluated cumulatively. For example, during a correction, the price of most crypto assets falls, but if a particular project makes a big announcement, its token’s price can skyrocket in the medium term.
Indicators, worth paying attention to
There is a set of indicators that reflects the current situation in the crypto market and allows predicting cryptocurrencies’ price trends. Paying attention to them, a trader completes the picture of what is happening and forms a complete view of the activity on the cryptocurrency market.
This indicator shows how interested the community is in cryptocurrencies (either individual cryptocurrencies or the whole industry). Google Trends is also often referred to as a “hype indicator”. For example, you can use it to find out if the general audience is interested in cryptocurrency or if the market is driven by whales and crypto-enthusiasts.
If you look at the number of “Bitcoin” queries, you can see that despite the rapid growth and overcoming the $45,000 mark, bitcoin is far from its peak search results.
BTC dominance is just as important for the crypto market analysis. It can be used to determine which assets are worth paying attention to at the moment. Often, when bitcoin dominance increases, altcoins “drop in price.” Conversely, when bitcoin dominance decreases, an alt-season often begins. At that time, altcoins begin to rise, and the price of the main cryptocurrency may correct.
Take a look at the chart: when bitcoin dominance rises, the market cap of the top altcoins begins to fall. But when BTC Dominance falls, the influence of the altcoins starts to rise actively – that’s what is defined as an alt season.
Fear and Greed Index
The Fear and Greed Index shows how overbought or oversold an asset is. The image shows that the indicator has reached 93% – the level of extreme greed. It means that the buyers’ power may run out at any moment, and the rate might undergo a correction.
At such moments, it is recommended to close long positions or place Stop Losses to prevent considerable deposit drawdowns in case of the cryptocurrency price collapses.
Longs to shorts ratio
This is another useful indicator that shows which positions in the crypto market currently prevail: long or short. The Bitcoin shorts vs longs indicator allows you to assess the sentiment of traders and assume how the price dynamics may change in the near future. For example, when the number of short positions starts to grow, it signals the strength of the bears. Right now the number of long positions exceeds the number of shorts by over 15 times. This may indicate that the situation may soon turn sharply in the opposite direction.
These are basic indicators that will be useful for those who are new to cryptocurrency trading. Each of them has its pros and cons, but these indicators work best when combined. There are other useful indicators for more advanced traders, such as the Bitcoin Market-Value-to-Realized-Value (MVRV) ratio – the ratio of bitcoin market value to its realized value. Because of the lost coins, the calculation of average capitalization values is distorted. MVRV coefficient eliminates this drawback.
Fundamental analysis is the backbone of crypto trading. It is necessary to consider the factors which influence the dynamics of the market at the moment prior to using technical indicators in order to estimate the local movements of cryptocurrency rates. Fundamental analysis will require some practice but there are a lot of training resources which are easy to find on the internet for those interested.