When to exit the market? Identifying the peak using patterns, news, and Livermore’s normal reaction

In 2021, Bitcoin hit an all-time high of $48 000, and Ethereum topped $1700. What should you do with long positions: close them or hold for further gains?

Together with the crypto exchange EXMO , we explain how to determine the end of a bullish trend using patterns, the Livermore method and news analysis.

Reversal patterns

Patterns are recurring combinations of bars on an asset’s price chart. Patterns with high probability signal trend continuation, its reversal, or consolidation followed by a breakout.
Trading by patterns works like this:

1. The trader looks for the pattern’s start, for example a local trough and peak.
2. First he defines the condition for pattern confirmation: a breach of a price level, a bounce or a consolidation.
3. Then the trader waits for the pattern to form and be confirmed. For example, reversal patterns are confirmed when a daily candle closes below the support level.
4. After pattern confirmation the trader opens a position in the forecasted direction.

A breach of a support or resistance level is a prerequisite for the pattern to trigger.

“New traders should combine reversal patterns of technical analysis with support and resistance levels. Near meaningful levels there is a tug-of-war among big players. It is especially important for a novice to take this into account to stay in step with the market,” says the EXMO chief operating officer Sergey Zhdanov.

Some of the simplest and most reliable patterns for daily-chart trading are \”Double Top\” and \”Head and Shoulders\”. They help traders identify a reversal of a bullish trend.

The Double Top pattern consists of two highs that close at similar prices.

On the chart: two highs with a trough between them.

Construction: draw a horizontal support line through the minimum.

Confirmation: the daily candle closes below the support line.

\”Double Top\” on the BTC/USD chart when the 2017 high was reached.

The Head and Shoulders pattern forms from three consecutive peaks.

On the chart: three peaks with troughs between them. The middle peak is the highest; the second trough is usually higher than the first.

Construction: draw a support line through the troughs.

Confirmation: the daily candle closes below the support line.

\”Head and Shoulders\” on the LTC/USD chart in August 2020.

Pattern trading works best on daily and weekly charts. Do not search for patterns on hourly or minute charts: market noise reduces forecast accuracy.

The Livermore Method

Jesse Livermore—a market speculator who made millions from short selling. Early in his career he developed his own trading system, through which he predicted the stock market crash of 1929.

In the early years of the Great Depression, Livermore opened short positions on the stocks of the largest companies of the era. From 1929 to 1932 the Dow Jones fell from $380 to $42. At the same time, Livermore earned about $100 million in profits.

In the early years of the Great Depression, the Dow Jones fell by ninefold, while Livermore’s fortune rose by about 30x.

Livermore described his trading strategy in the book How to Trade in Stocks. The strategy calls for analysing price action near base points: historical highs and lows, as well as \”round\” price levels of 50 and 100.

\”We, as the exchange, observe elevated trading volumes near former highs and near \”pretty\” levels like $500 or $1000. At such levels a significant volume of limit orders often accumulates,\” remarks EXMO’s chief operating officer Sergey Zhdanov.

Livermore described two possible outcomes when base points are breached:

• normal reaction — the daily candle closes 2–3% above the base point after breach;
• abnormal reaction — the daily candle closes below the base point after breach.

Livermore’s method on the chart of DASH/USD. When the levels of $500 and $1000 were breached, daily candles closed above base points. When breaching $1500, the price retraced below the base point and the trend reversed.

Livermore bought the asset when the price breached the base point. After that, he watched the price movement and the daily candle close:

• in a normal reaction and price rising above the base point, Livermore held the long position for several days;
• in an abnormal reaction — he closed the position or opened a short.

Fear, Greed and News

Among traders, there is a popular legend about a shoeshine boy. Investor Joseph Kennedy sold his investment portfolio a few days before the market crash. He told colleagues that on the way to the office he stopped at a shoeshine stand.

The boy told Kennedy that he planned to put $40 into shares of the local railway. Kennedy concluded that if shoeshine boys are making money on the market, the stock market is about to fall.

Shoeshine boys are a thing of the past, but market analysts still monitor crowd sentiment. Crypto market participants do this with the Fear & Greed index.

Fear & Greed measures crowd sentiment from cryptocurrency volatility, spot exchange volumes, and hashtags on Twitter and Google Trends. The higher the index, the greater the likelihood of prices declines.

Fear & Greed on February 10, 2021. Prices close to the highs.

On February 9, Lepra published a post about Bitcoin at $48,000. This is the channel’s second mention of the cryptocurrency.

On February 9, Bitcoin price reached a peak.

News and Fear & Greed should be used to gauge sentiment among holders of popular cryptocurrencies. These tools do not help with altcoin trading: media rarely cover low-cap coins, and indices do not track their trading volumes or volatility.

The chart shows price movement of assets in percentage terms. In early 2021, Bitcoin price (blue) rose gradually. Meanwhile, YFI price (red) fell due to waning investor interest in DeFi. DOGE price (green) surged 20x thanks to Twitter mentions.

How to identify a trend reversal in a bull market

Prices can rise 100% in a week and fall just as fast. In periods of high volatility, it is important to close a long position in time.
A trend reversal can be detected through long-term and short-term signals:

• Open the social-media news feed, scan entertainment media, and check the Fear & Greed index. An index above 80 and notes about new price highs signal a possible change in the long-term trend.
• Examine the asset’s chart for reversal patterns. They appear every few months and may indicate the end of the medium-term trend.
• Identify base points on the asset’s chart. These include historical highs and \”round\” levels. An abnormal reaction when breaching base points signals a possible reversal of the short-term trend.

Conclusions

Long positions should be closed as close as possible to the historical maximum: before the price peak, at the peak, or after it.

The ideal moment to sell assets can be found using the Fear & Greed index, news analysis, the Livermore method and reversal patterns.

Remember that no method of technical or fundamental analysis works 100% of the time. Manage risk and do not invest money in cryptocurrencies you are not prepared to lose.

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