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On Algo Bots and Why We're Likely to see another Dip below $6k

During this last draw down in Bitcoin markets from 10k to 5.8k I learned a lot about algorithmic trading bots ("algo bots"). These bots often are used by "whales" given that a profitable algo bot will allow you to make a lot of money and accumulate a lot of cryptocurrency that can be used to influence price action. This puts the ordinary trader at a huge disadvantage UNLESS they understand how these bots work and what market dynamics favor the bots and which ones do not.

The primary market dynamic that favors trading bots is low volume. In low volume condiions these bots effectively can dictate price by "entraining" buyers or sellers and other bots. For example, the idea of a "sell wall" or "buy wall", that is, a large cluster of orders that one can see in the order book or on the order book graph, will influence other buyers and sellers as you will either be "entrained" or you will "get out of the way." Both of these scenarios present problems as the optimal outcome may not be clear if you're under pressure to make a decision that hasn't been planned out according to an overall understanding of market conditions. Not understanding fundamental market dynamics is a key reason technical analysis fails. Charts won't actually tell you exactly what is happening in a market with data. It is usually suggesting a direction and often only telling you something important after it's too late (see for example how bad MACD is at prediction).

But I'll talk more about the mechanism of how algo bots work later. If you want to read my streamed commentary you can see a recent piece that I published about a greater than 50% probability of another decline where I slowly built my (admittedly still weak) understanding of how these bots influence price action. And if you're skeptical about what I'm describing then I'm open to constructive feedback or corrections. But I'm going to cut to the chase while skipping over some of the technical aspects.

In the current market we're looking at what appears to be a strong recovery from a 31% decline from $8400 to $5800 (on GDAX) and a retrace of 58.3% of that price movement.

Given the first wave of price movement off of the ATH took 26 days to hit a reversal and the second wave took 15 days, the current reversal will likely be very soon, as we are about 5 days past the last reversal (Feb. 2) today, near the end of the day Feb. 6/start of Feb. 7.

In order to signal a reversal this bullish move needs to hit 8k (low of the previous wave on GDAX prior to reversal) and ideally it goes above 8.4k which was the high point of the current draw down to fully signal a potential (but improbable) move higher.

The fundamental reason for momentum (i.e. a pump) is that buyers as an aggregate can see when there will be sufficient momentum for a price movement and they are "entrained" so as not to be left behind. This is basic pack/herd behavior as I would surmise is understood by evolutionary game theory ( not going to get into that ). Those who choose to stick with the herd have higher probability of survival/success. Venturing away from the herd makes you more likely to become a victim of your "individuality".

Clearly, the market is positioning for selling more than buying. This kind of signaling plays a role in warning buyers to enter the market with caution (at least for longer duration trades). For example, if someone is quite eager to sell you a car at a great price, you might think, what's wrong with this car? And in this instance, we should think, what's wrong with this market? Clearly, there is fear. And then there is also now a conditioned expectation that another huge sell off could happen at anytime. This makes for enough weak hands for more volatility.

The ONLY way this could be reversed is if some HUGE buyers enter the market. So let's say a bunch of millionaires all collude to go and buy Bitcoin so the price goes up.

Catatan

The problem with this idea is that a bunch of millionaires with a financial background would look at the market conditions and say, well we're not getting the best price and a lot of buyers are positioned at 5k-5.5k. Let's push the price back to that level, enter and then make huge profits off of the "pump"/entrainment effect.

Catatan

Given the conditioning that losers will have to be risk adverse in entering the market again, in all likelihood price will stay depressed for a period of time once the overall price reversal off the ATH is complete. However, there will likely be extreme volatility, and that will be an optimal time for profitable trading if you know what to expect and can readily monitor order flows for price manipulating algo bots to avoid positioning yourself incorrectly.

So the fundamental idea here goes:
1) we're not seeing enough momentum / order positioning to break the 8k SELL WALL (soon to be 7.5k SELL WALL)
2) algo trading bots will take advantage of declining volume and momentum to push prices back down to a level where a lot of other buyers are positioning themselves given the right conditions (i.e. near 8k) (BEWARE OF WEEKENDS and OVERNIGHT). Once the "sell train" starts rolling you either get out of the way or get killed. Even Satoshi Nakamoto couldn't stop a huge sell train.

3) Positioning yourself with THE HERD will protect you from entering or exiting the market at the wrong time. Look at order books/graphs to figure out where the BEST place is for a longer duration trade amongst the largest cluster of BUYERS/SELLERS. You can also use this for short duration, smaller order size trades profitably. I feel like this actually works better in a downward trending market as it can be hard to beat buy and hold in an upward trending market. Obviously you won't profit if you hold during a downtrend but these short duration trades can offset some losses in your longer duration portfolio if you do it correctly. (BIG IF)

4) We're in the very near term end of a bearish price move that could be like a descending wedge we'll likely continue to see massive volatility at increasingly short intervals. Traders are conditioned now to be extremely sensitive to a rapid decline in price. Given equity market volatility this could all be contagious to risk aversion in markets overall. So be warned.

5) That being said, the overall risk:reward for Bitcoin/Litecoin and a few others appears to be very strong at current prices. So in theory you could do nothing for 6 months at this price level and have a high probability of making money. So if you're in a position started at 7.5k or less I would say that's pretty good. We might see a final draw down to 50% of that, but basically the sky is still the limit for Bitcoin prices over the 2-4 year time horizon.

I would set aside 25% of your trading portfolio for a move to less than 5k and try to enter with at least 50% at 5.5k (or the equivalent for some other coin that you think will bounce, like BCH, ETH, or LTC). Then you still have another 25% set aside for the sake of risk management/contingencies. This will depend on what the order book is telling me so that can change at any time.

ETH had an incredible bounce and I fully expect any draw down to below $500 could reverse for 100% gains over a short duration. But I haven't looked at the order books or anything so that's just a guess. And Ethereum also has relatively more regulatory risk related to it compared to Bitcoin.

Catatan

Just to be clear, there's no indication yet that buy volume is low enough for a reversal back to 6k.

Also, observing Bitcoin Cash (BCH) it is VERY obvious that an algo bot is pumping the price with an unusual 350 BCH order that bounces around in the BID order book somewhat close to the market price but not too close creating the illusion of demand. This is by far the largest order on either the buy or sell side of the order book and clearly has the ability to influence other bots/traders into aligning around its behavior.

Catatan

The order book for BTCUSD on GDAX has really taken a nosedive with significantly greater sell positioning below $8450 than buy positioning above $6900. Two big buy clusters are positioned around 5k and 5.5k but order volume between 5k and 5.5k is far greater than that between 5.5k and 6k and between 6k and 6.5k.

All of the order volume above 6.5k is roughly equal to the order volume positioned between 5.5k and 6k. And the order volume between 6k and 6.5k is maybe 20% less than that between 5.5k and 6k.

So about 1/3 of all order volume above 5k is set between 5k and 5.5k, another 24% is above 6.5k and another 43% set between 5.5k and 6.5k in a fairly linear distribution.

Catatan

On GDAX there appears to be a price manipulating algo bot pushing price higher as well. This led to a dramatic increase in volume around 2:35 AM EST that led to a rapid increase in price from $7437 to $7747.

The bot is very obviously inflating the buy side order volume by just enough to get the price towards $7800 where there appears to be enough selling volume to push the price back down.

Catatan

Before even contemplating a trade it seems smart to observe the order book and look for unusual activity from bots that could give you a clue about the market. That being said in a high volume market this doesn't always work but in a low to medium volume market it becomes much easier to see rapid price changes.

Catatan

I'm not sure if this algo bot has pulled in enough buy volume because based on order positioning were about to see a over 400 BTC get sold between $7930 and $8000.

However, this bot is still clearly at work, throwing in and cancelling orders at just the very edge of the order book graph when you're zoomed in to keep the volume from dropping off completely.

It will be interesting to see how this plays out.

Catatan

I'm wondering if the buy volume here is largely being entirely generated by other algo bots or if real human traders are hitting buy despite what appears to be a massive amount of selling that's about to happen. It just doesn't make sense to me.

Catatan

It seems like to benefit from selling off at this price target you couldn't have that large of a position given the minimal amount of buyers on the market once you hit that target so I'm not even sure if this is an algo bot strategy or if I'm just imagining things.

Catatan

There's $3.2 M in sell orders below 8k and only $1.5 M in buy orders above $7888. So how is this going to end well for these poor buyers? Will the sell volume get lifted to push the price higher? I'm not sure what the rational expectation is for buyers entering the market right before a shit ton of sell orders are positioned.

Catatan

It definitely seems like you would need to be on both sides of the trade to benefit somehow from this strategy. Because if you're having to buy up more BTC to create demand and push price higher then it can become costly. However, if you're manipulating other algo bots into buying ahead of you then perhaps you end up buying relatively few for the marginal profit that you're gaining.This really needs a simulation.

Catatan

Then because there's a large "sell wall," a lot of sellers could be jumping in front of your position and an optimization would need to be done for the target price level.

I just don't understand how the price is staying up like this despite almost all of the buying volume drying up. If the algo bot intends to hit a price target then it wouldn't want to signal that price target unless it wants to attract more sellers to it. That would make it harder to reach the price target. So then maybe it's just a general pressuring of buy volume without actually any buying, which could eventually exhaust a large sell wall and allow price to creep higher to an even larger sell wall/price target. I suppose if you're able to build enough momentum on the buy side then the volume will increase and more buyers will buy into the FOMO momentum. On declining volume maybe this doesn't work.

Catatan

My main takeaway here is that during lower volume trading I shouldn't assume too much based on the order book and graphs because I don't quite understand what's going on. I should stick to my plan and contingencies or just hodl.

Catatan

Out of nowhere a huge order popped into the bid order flow and the sell wall was lifted and now that sell volume is nowhere to be found. Wow. The market definitely did not just clear 300 BTC in an instant.

Catatan

It's just so easy to put small orders all through the Ask so that when buys come through you quickly blow through it pushing the price higher even with very light selling pressure.

I just saw the price skyrocket 1.6% in 5 minutes on almost no sell volume simply due to these small orders. Clearly, a rational human trader isn't setting tiny little sell orders at weird prices throughout the order book. I wonder how much activity happening in exchanges is "real" and how much is created by bots.

Catatan

It seems that if you're pushing prices higher by buying incremental quantities of BTC on the way up and selling it for higher prices at equal quantities then you'll end up making money with the light volume that occurs in between price levels.

So this would explain why areas of the order book in between "notable" numbers like 8k, 8.5k etc. could see very little support or resistance due to the ease in which algo bots can "seed" the order book to facilitate price movement.

Catatan

If I were to replicate this bot I would be looking for areas of the order book where there was very light matching volume at specific intervals, say adding up volume on both the bid and ask every $250 up until you hit a limit of volume in which the order bot could not place a large enough order to move past that level but would need to rely on the market but could help push order volume some other way on the other side of the trade. You would want to see the order book at some interval that would be optimal for driving the price by matching or exceeding the buy volume just below the mid market price. This would allow order matching that drives the market price higher until you run into larger orders that would take more time to fill and take the market price out of the bot's influence until those orders are filled and then you can drive the price again through the low volume areas.

Catatan

Once you clear through the existing orders of a particular price level that causes a dip (or a rise if you're pushing lower) then your bot can automatically seed the price levels very quickly to cause a rapid increase (or decrease). So even with a lot of volume to clear, as long as the bot can entrain buyers or the buy volume continues to come from somewhere (this is what doesn't make sense) then the bot can clear through the order book and seed it with its own volume that can move the market price.

Catatan

Clearly, it would not be cost effective to move against another large influential player (or group) in the market and the best strategy would be to collude even if it is implict. This incentive is generally bad for the market as the price discovery does not happen organically based on actual supply and demand. It is happening due to market collusion that forces artificial supply or demand conditions that influence price.

Catatan

Then when the primary players in driving price find conditions to be ideal for a reversal or market conditions dictate a reversal (i.e. out of control market) then those who were under the impression that whatever pattern they were seeing would continue to last lose and the winners will tend to accumulate more wealth.

Catatan

Given the current reversal it's pretty clear to me that Litecoin and Ethereum have much bigger bounces and while BTC will be the gauge for how the market reacts, your profitability will be better buying ETH or LTC on a dip. They're up like 45% versus about 40% for BTCUSD. It certainly appears to be a nearly full retrace of the previous draw down.

Shanghai SE Composite is down 1.82% and the Hang Seng down 0.89% so if this global volatility continues it could trigger another quick reversal back to previous lows. It will be interesting to see if global equity markets volatility has any effect on crypto. Judging by the reversal today I would guess not.

Catatan

The bigger problematic issue is whether another draw down will see a close below 6k. If we close below 6k then that's a big problem since the bottom could basically fall out of the market. The price manipulation forces at work here are dangerously close to harming itself though perhaps they already have enough wealth that it doesn't matter. Perhaps the optimal scenario would be a relatively calm period of gradual price increases free of panic selling.

That would be extremely interesting if it were to happen. During the last period in November 2015 when prices dipped this low it took over a month for prices to recover and then dip again before finally reversing fully. But that was at least 80% off the ATH and the 80% off the ATH level would be around 4k. So not exactly a great sign if we're at 8k right now and still about 10X above the low from a year ago.

Catatan

Interestingly, some of the order positioning from between 5.5k and 6.5k has shifted above 6.5k. So the market has a weird shape if you were to only chart out total volume between "5k and 5.5k", "5.5k and 6k", and "6k+".

And as I write this the volume above 6k magically increased by 30% so now it's even more bizarrely shaped.

Not sure if we're getting some major FOMO positioning or what.

So on GDAX it would be about 20 M, 10 M, 30 M for this chart. In a linear demand world we'd be seeing something more like 30, 20, 10 (hypothetically and not precisely) which would be consistent with yesterday where we saw 20, 15, 20 (i.e. 10, 5, 2.5 if you distribute it the same).

I would expect prices to bounce around 7250 based on the demand. There appears to be unusually sized orders placed between 7160 and 7250 making the order volume balloon in that area. It's the same between $8300 and $8500.

I wonder if this inflated order volume is an attempt to manipulate the market. Overall Bitcoin "Direct Volume for the last 24 H) has dropped 30-40% so whatever enthusiasm / momentum occurred yesterday and the day before has not carried over at all. If we see another lull with volume dropping by another 50% then that will be a sign that the markets could be easily manipulated.

Catatan

I'm just going to straight up say that Bitcoin Cash is a total shitcoin that is being manipulated by Roger Ver and his colluding parties. We could write a really great paper on how they're doing it too.

If you look at GDAX order book with orders aggregated to $10 intervals (the + button) you will see at $980-$990 order volume spiking and then going lower (with no other numbers moving). Clearly someone is using a bot to place and cancel large orders to create the illusion of more buying volume than exists. In regulated markets this is illegal.

See: theguardian.com/us-news/2015/nov/04/us-high-frequency-trader-convicted-first-spoofing-case-michael-coscia

Catatan

I will say that the order volume changes very dramatically so not like by a few dollars but by 30 or 40% of the order volume. This is bizarre because on the sell side there is absolutely no volume and this huge spike came out of nowhere and basically doubled the buy volume above $990.

Catatan

Clearly a few people understand this phenomenon quite well:

youtube.com/watch?v=A7LjAPef3ys

This article is pretty thorough (and where I got the link above):
cryptocurrencyfacts.com/cryptocurrency-and-spoofing/

Catatan

This is a great article:

steemit.com/cryptocurrency/@goldgoatsnguns/will-cryptos-end-trade-spoofing-or-enable-it-it-s-our-choice

Catatan

As expected a pretty strong bounce off $7500. I'm almost too shell shocked right now to trade.

Catatan

Some momentum building on the sell side now. And definitely still a lot of buyers lined up to buy the dip with basically the same volume between 5k and 6k and $5.5 and 6k. Since we're trending down some volume has been "eaten up" above 6k. So this creeping price action could bounce around a bit between 6k and 7.5k though the expectation will be that a move below 7k could trigger a volume shift/panic...

Catatan

It seems like a very clear pump across at least BCH and BTC markets now. The sell volume is so thin it would be easy to buy up all of that (or trigger buying across that range). And as we saw yesterday, when volume dips it becomes much easier to pump, repeat, and pump again until the market either entrains enough new buyers to roll higher or exhausts itself and then it becomes a race for the exits.

I feel like we're very close to "capitulation," but perhaps we'll continue to see medium term strength in the markets due to how much some people have lost so far (i.e. denial). I would be extremely strict about portfolio allocation, with no more than 20% in long duration crypto assets and no more than 5%

Catatan

not sure what I was going to say at the end there as I got distracted by something. Looks like that pump worked after all... at least for Bitcoin.

Catatan

wow. the order book looks HORRIBLE right now. Why ANYONE would be buying above 8k is insane. There's $10 M in buy orders above $7300 and $26 M in sell orders below $8933...

Catatan

I'm learning some market manipulation terminology - throwing orders all across thin volume is called "layering." And throwing up orders and cancelling them is called "spoofing."

Catatan

Live "Crypto-Asset Bubble" Panel at World Economic Forum in Davos Switzerland

youtube.com/watch?v=EIy6240Dsts

Catatan

volume really picked up on GDAX above $8500.... and earlier around $8200....

I just don't know where this volume comes from because there isn't much order positioning and buy volume looks terrible still...

Catatan

For example, why would there be so much volume positioned at $8250 and almost nothing at $8000... makes no sense...

Catatan

I think if you're willing to take a small risk and play with fire then Bitcoin Cash has a lot of potential given that Roger Ver and company have huge incentives to manipulate the price back up. On the other hand, maybe Roger owns most of the coins on that network and just trades them with himself to keep the price up. Once everyone else sells off he can be Bitcoin Cash, all by himself, tweeting to himself all day about how he owns all the "real" Bitcoin...

Catatan

Huge sell order just went up at $7900 so we'll see what happens on the buy side. Looks pretty thin...

Catatan

Bitfinex with a ~+$50 spread on GDAX

Catatan

It definitely seems like Spoofy has been turned off for BTCUSD. But sell volume is still thin enough that Picasso could be working to prop up prices.

Also, Tethers were supposedly printed so if we start to see a big + spread on some of the Tether exchanges then that could be a possible sign of wash trading with fake money...

Catatan

Buy order volume above $6500 has dropped by at least 1/3 since yesterday so fatigue in the market appears to be growing.

Catatan

the market looks like it could trade sideways for a while... which would suggest "normal" conditions.

Catatan

This 9% rally is starting to gain some strength but the sell volume at $8500 could knock it back.

Catatan

overall market still looks incredibly weak. not sure why anyone would be buying XRP right now, but I guess those are the gamblers trying to win back their losses...

Catatan

XRP has circulation of about 25% less of its total market cap than Bitcoin on 82.5% less volume. This kind of thin trading means price discovery is poor across some exchanges which could allow certain exchanges to manipulate price more easily.

For example if I own 80% of all XRP trading in S. Korea (or collude with a large enough percentage of XRP owners that we control over 50% of the volume) that I bought at less than 0.10 I'm going to have extreme price control in the market. This is an extreme hypothetical scenario. Essentially I could have a monopoly simply by buying more XRP by pressuring the market price lower (as long as you buy more than you sell) and then command higher prices by restricting supply to increase bids while pumping XRP on social media, etc. This model is likely completely automated by many of the trading groups/individuals who use bots for both trading and social media.

This price manipulation will lead some to believe in the correlation between XRP news, positive price action, and social media sentiment and then the FOMO positive feedback loop begins as people gamble on crypto believing they can become insta-rich even though they are "noobs" and don't understand any of this stuff.

Catatan

Even though this is an extreme hypothetical this is EXACTLY how pump and dumps work. Teenage kids have deployed this strategy since the early days of the internet to become millionaires.

If you are a savvy pump and dump schemer this is basically free money. You take your trading fund and buy up as much of some crypto as possible when it is very cheap and you believe there will be positive sentiment at a later time. Then you deploy bots for trading and social media presence (easily sourced through internet freelance sites) and maybe even build your own content site to pump the coin.

Ideally you want a limited presence on a handful exchanges, like with an ICO token, so you can corral enough volume on those exchanges to start manipulating prices with your huge stack relative to the total volume being traded.

This is essentially every ICO and pre-mine/insta-mine coin out there and has been documented here:

On another note, on-chain transactions for Bitcoin have only been averaging 203,000 per day over the last 6 days. Not a good sign if we're thinking about Bitcoin as a network that gains its value through growth. Even if it is a store of value you would think that the network is growing rapidly enough to see an overall increase in on-chain transactions over time, but instead these numbers have more or less peaked and declined to the same levels as late 2015.

What we're seeing is an increase in transaction volume volatility, which might be a sign that a lot of people are going in and out of the market, so instead of keeping a stable value, we're seeing these massive price changes that reflect extreme uncertainty in the market about the current valuation. This would seem to be a sign that the market could stabilize after a fiery and unpleasant decline that results in an extended period of relative calm.

Looking back at Nov. 2013 to late 2015 you can clearly see transaction volume spike (from the price manipulation of Mt. Gox / bots) and then decline siginificantly. After this crash transaction volume stayed fairly steady for about 6 months before increasing steadily through late 2015 when transaction volume volatility began to return to the market.

During this period many companies which had organized to enter around the time of the big "boom" in crypto flamed out and by 2015 the market was probably finally starting to recover enough investment interest that transactions picked up significantly.

Given the current state of the market I would be very cautious about taking any long duration positions with the expectation of hitting a 6+ month price target. It's highly likely that we'll be seeing a bear market where prices decline back to previous levels and until exchanges signal that they've leveled the playing field by weeding out bad actors the market could get worse before it gets better.

Catatan

Demand has shifted higher above 6.5k in the order book but the market still looks decidedly bearish below 10k. Given progressively declining volume it doesn't seem like the market is buying into this rally.

Since I've decided to sleep more during peak algo bot trading hours when volume is low I haven't really noticed much suspicious activity lately. There still appears to be what I think is layering but not really any spoofing and probably less wash trading too as I'm not seeing these rapid changes in price through thin sections of the order book.

Catatan

That being said, the bulk of the price move in this rally seems to have happened between 1:30 AM and 3:00 AM when volume picked up very suddenly at around $7900. If I were concerned about my activity being detected that probably would be an ideal strategy. Get in and out during a smaller window and not be so conspicuous that people are shouting about it on Twitter and Medium.

Catatan

The other strategy would be asset rotation (i.e. manipulate another coin so it isn't so blatant). Clearly, Bitcoin Cash's price move looks very suspicious and spoofing and probably wash trading was so blatantly obvious the other day during extremely low volume. Magical buyers of Bitcoin Cash don't just materialize out of nowhere. But then again, maybe people get off work and go trade crypto...

Catatan

Litecoin volume is way down at less than half of what it was during the recent spike in volume and I would think this makes it the ideal candidate to manipulate prices. However, even though it also shows a strong move between 1:30 AM and 3:00 AM like BTC, the volume seems to be relatively normal during that period so perhaps this is based on some other positive sentiment.

Given the charting suggests we need to visit 5k before a reversal I could see a reverse head and shoulders that forms over the course of early March. This would be a good sign that the market has stabilized.

However, given Bitfinex's sketchy ass position in driving price discovery and the very distinct possibility that they have essentially been repeating the mistakes of Mt. Gox, that is, 1) get hacked and lose a ton of money 2) fake a bunch of price action so as to keep your business running 3) fake print a bunch of crypto and allow sketchy market cap cryptos (aka Bitcoin Gold) to be traded to inflate your valuation / volume 4) market loses faith based on big negative news/sentiment, volume and price drops off considerably and you go bankrupt.

Catatan

We'll need to see some magical unicorn buy volume appear out of nowhere to get above $8700 and the order positioning above $8300 is pretty light....

Catatan

Considering how few market buy orders I'm seeing this doesn't look like a strong market but there's probably not so much sell volume for price to get below $8600 any time soon which means there could be enough buy volume *eventually* to push past $8700.

I'm not seeing rampant bot action and a pretty calm market so now I'm feeling like maybe I've blown this all out of proportion... but in general, when you look at the systemic risks of the global crypto market, this is still a ticking time bomb. Perhaps Coinbase is getting their act together. Until Bitfinex has opened themselves up to being transparent about their finances and exactly what is going on with Tethers there's a lot of reason to be concerned about current valuations.

Catatan

Now that I thought about the Litecoin move there are likely arbitrage algo bots that watch for sharp changes in various coin pairs such as LTCBTC and then buys/sells based on arbitrage opportunities which is why price tends to be so tightly correlated even during low volume hours.

powderpc

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