A Guide to Trading Cryptocurrency Part 3: Bill Williams’ Method

Markets are chaotic. Cryptocurrency markets, even more so. But just because the markets are random and sentiment can shift rapidly does not mean you cannot profit from fluctuations in the price of bitcoin or altcoins.

Psychologist Bill Williams Ph.D. developed a trading method in the 1970’s to trade future markets, but can be applied to cryptocurency markets as well. The essence of his philosophy is that markets are chaotic, random, so first we have to understand the fractal nature of everything around us as well as the market. Also, the market psychology is the composite of all human trader’s psychologies, so we can use the rules of human psychology to gauge the market.

Learning to Live with Chaos

Standard methods of trading, such as using linear support and resistance levels, are misleading and do not account for chaos in the market. We are trapped into thinking in terms of cause and effect. We use straight lines to read the market, of course we will go wrong, as you will not find many straight lines in nature, with the exception of crystalline deposits. Our logic based on mathematics and the scientific method is being renovated by developments in Chaos theory, which is not as bad as it sounds, as chaos is just a higher degree of order.

We all trade our own belief systems; by discovering the underlying structure of the market, then being able to reasonate our personal underlying structure with that of the market, results in geometric harmony.

Markets are characterized by energy. Energy always follows the path of least resistance. For example, imagine a river flowing down mountains, which follows the riverbed because that is the path of least resistance. Its movements and patterns, whether the river is flowing rapidly or calmly and in which direction, depend on the underlying structure of the riverbed. Many approaches to trading is analagous to an attempt to change the underlying riverbed, whereas Bill Williams’ strategy instead identifies the structure and you should be able to instantaneously identify where to buy and to sell.

Structure and Fractals

The underlying strucure is best described by a concept known as a fractal. Most traders are poor at making profit since they are using the wrong maps, so of course, they will get lost in the chaos of the markets.

Bill Williams’ trading method relies on several indicators that uncover the underlying structure of the market and aspects of its energy. Also, a dose of psychology to understand the market as if it were a person or an animal. For example, in Trading Chaos, Williams states:

“Two often repeated formulas for successful trading are:

(1) Buy low and Sell High, and

(2) To make profits, trade with the trend.

These two statements are absolutely incompatible. If you buy low or sell high, you stand in the way of the trend, not following it. And if you follow the trend you are not buying low or selling high… As we start eliminating these misconceptions, we can begin to see the market as it really is.”

Know thyself and know thy market, these are the two commandments of the chaos approach to trading. But how do you get started with the chaos approach to trading?

We will examine fractal geometry and its application to trading bitcoin and cryptocurrency. Perhaps the best visualization of a fractal is the Mandelbrot set, shown below.

Zooming into the Mandelbrot set, we see self-repeating patterns that go on and on. The image above also captures the 0.618 ratio, or golden ratio, that is so often found in nature and revealed by the Fibonacci sequence.

Essentially, a fractal is a measure of irregularity and is also a term meaning ‘fractional dimension,’ referring to how we look at things far away may seem one dimensional but then as we get closer it becomes obvious it is three dimensional. For instance, the two images above illustrates this phenomenon. So, as with the market, depending on your perspective, your point of observation will determine what you see.

But before we examine fractal geometry further, let us achieve a better understanding of chaos, as the word has negative cononotations.

Your never view the world as it really is. Every person filters certain things out of their experiences based on their world view, their philosophy and their beliefs. We see a partial reality. Same thing goes with the market, we only see it partially, not entirely, we are all biased toward seeing parts of the market that agree with our perspective.

Chaos is, therefore, the things going on you do not understand, that you are unwilling to process since it conflicts with your beliefs or your perspective of the world. Once you accept this fact, that your particular paradigm that you view the market through determines your feelings and behavior, trading is more enjoyable and less stressful.

Deeper into psychology side of things, chaos is a higher form of order where randomness and stimuli become the organizing principle rather than the more traditional, Newtonian ’cause and effect.’ Since both human nature and the human brain are chaotic, this spills over into cryptocurrency markets.

There are three principles to consider when studying the market’s energy. Firstly, energy always follows the path of least resistance. See the surges and drastic drops in cryptocurrencies as waterfalls, as they are essentially the same natural phenomenon.

Secondly, this path is determined by the always underlying and usually unseen structure. By examining the underlying structure of the market and recognizing any change in the structure is one part of trading. The other part is to probe your personal underlying structure, as your routines and daily habits determine your approach to trading, your behavior and your reaction to any movement in the market.

When your personal underlying structure is aligned with the market, winning becomes the path of least resistance. As a trader, you will know when you are going against the path of least resistance, tension builds up in your body and mind. You are not “floating down a river” as Williams puts it if you are tense.

Thirdly, the always underlying and usually unseen market structure can be discovered and can be altered. Much like the structure of a river may be altered if the area near the spring was manipulated, the market structure can be altered in minor ways to produce big changes in behaviour.

“You Can’t Fool Mother Structure”

Most of us, especially in cities, in our minds we are disconnected from nature. If chaos and fractals are new to you, then after reading this guide you should see your life not as a struggle against nature in a dog-eat-dog world but rather as a struggle intimately connected with nature and the market. After bankers and our governments have foresaken us all to ever-rising debt, a part of our struggle is a social one with bitcoin, if we partake in the “Big Long” (a rejection of all fiat and hold all wealth in bitcoin).

Most traders will tell you behavioral traits are key to success but structure is imperative. No matter who is within a structure, the results are the same. One structure of life and thinking leads to oscillation, while in contrast, another structure toward life and thought leads to a final destination. We examine each in turn.

As Williams puts it, a Type One structure oscillates, producing an action-reaction, back-and-forth type of behavior, reminiscent of a pendulum and this is the structure most traders are operating within. For example, suppose you put a trade with a tight stop loss, then the market move to this level to invalidate your trade. You tell yourself, “the stop was too tight,” and then proceed with a larger stop loss in the next trade. Yet, the market moves against you again, and you sustain a large loss. You think I cannot take such losses and move your stop loss higher again, in a psychological pendulum.

The Type One structure is also characterized in people who have quit smoking and crave cigarettes, been on a yo-yo diet or quit drinking and still craves alcohol. But if you are in this structure, fear not, as there is nothing wrong with you. It is the dominance of the left hemisphere of the brain. Addressing behavior is secondary, addressing your personal underlying structure is more important. We now detail a Type Two Structure to illustrate how to go about this.

“Notice the natural order of things. Work with it rather than against it for to try to change what is so will only set up resistance.” – Zen Proverb.

In contrast to Type One structure, Type Two structure is located in the creative part of the brain in the right hemisphere. While Type One results in a pendulum-like motion in behaviors, an attempt to solve a proble, a Type Two structure is geared for action that brings something new into being. Rather than solving problems, it creates results.

The problem-solving mentality has become a way of life, once you solve a problem and are successful, you have no problem left. Hence, you either create a problem for yourself to solve and the back-and-forth tendency consumes you. For example, anyone can put on a trade and win big, but if you are in the Type One mindset, you have solved some sort of financial problem, or solved a technical analysis problem, and finally nailed your strategy, you have then succeeded.

Automatically, when your left brain is dominating, you will put on trades afterward that will lose money as subconciously you have solved a problem and are in need of solving one, so you create another problem for youself to solve, that is losing money that you must then solve by making more profitable trades.

“Problem-solving does not create what you want as a trader (profits) but rather losses. Do not think you have to transform and revamp your trading you need to transcend it…”

Type Two structure is all about creation. You are at the helm of a high-speed bullet train, no room for backtracking, or wasted energy, every little behavior is contributing to your productivity. Unfortunately, creating is not a skill that is often found dissipated in the classroom or in the workplace. It is perhaps the imperative skill in trading. The creative process is very different to reacting to present circumstances and herein lies the key to successful trading.

Therefore, you should be mindful when trading, aware of your own brain and what part of it is dominating your behavior at each moment. Once we are aware of how our brain works, when we are in the Type One mindset, we can forget about trading or practice focusing our mind into a Type Two structure before putting any money on the table.

When responding to present circumstances, your are bound by the limits of the moment. When you are creating, there is no limit and the key is that there are no rules. Unlike anything else in life, it is all down to you to enforce discipline, set the benchmarks and make the rules. You trade when you want and how much you want. If you are comfortable to take a trade, then take it. If not, do not force it and accept that your structure does not align with the market’s. You create your own profits and you determine your risk. Trading is therefore very philosophical, as one has to “know thy self.”

Williams’ Path to Trading Success

If you are a complete begginer, you should analyse OHLC (Open-High-Low-Close), also known as candlestick analysis. Also, volume is an important indicator. In the beginning, we should learn what is going on and who is running the show. Volume will help identify this, as volume precedes price action, meaning a huge surge in buying/selling volume will point to gains/losses. Once you have grasped candlestick analysis and volume, we move to fractal geometry.

Mechanical systems are popular in trading, with futures traders swearing by the Market Profile system. But as markets are part of nature, mechanical systems are always destined to lose people money. Why? Because take, for example, Market Profile; it uses parametric statistics based on the assumption the market is random. Parametric statistics are not appropriate to examine non-linear behaviour.

Williams worked hard to find the underlying structure of the market, turning away from Newtonian types of investigation and insight toward chaos and nature instead. Utilizing two Ph.D.’s in theoretical mathematics and computer science and using a mainframe computer to perform sophisticated non-linear feedback calculus, Williams extracted exact fractal points in the charts and found a pattern that accurately reflected over 98 percent of the fractals found by the computer.

The Fractional Dimension, or Fractal

As a pioneer of this theory of real-time trading, Bill Williams unleashed the concept of market or behavioral fractals into the trading world. Any decision you make is a behavioral fractal. To trade profitably, we must recognize the behavioral fractal of massess of traders and understand the impending change in the bias of the market.

Examine individual psychological fractals on an individual basis and then analyze the market’s sociological fractals from candlestick charts.

For example, the chart below shows fractals, defined as a candlestick that has two preceding and two following bars with lower highs (for an up move), or higher lows (for a down move.) Notice in the chart below, up fractals are green and down fractal are red.

Suppose we look at the chart below for BTC-USD, this is the exact moment a fractal in the market has formed. Notice the high at $919.99. The two preceding candlesticks have lower highs and the two following candlesticks have lower highs as well. Also, notice the down fractal at $908.01. Notice that the two candlesticks prior have higher lows, as well as the two following candlesticks.

The up fractal at $919.99 is the fractal signal. The down fractal at $913.08, the most recent one before the up fractal, is the fractal start. Then we look for the fractal stop, which will be the most distant fractal peak/trough of the last two fractals in the opposite direction. In this case, the stop fractal is $908.01. So at this point in time, we automatically know where we will buy, the risk we will take, and where we will sell.

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We will look to buy just above $919.99 so say at $920.09. Next, we look to sell just below $908.01, around $907.91. Why do we not use the most recent down fractal. If we examine the chart and try to include about 100 candlesticks to get a feel for the structure of the market, we see a bullish Marubozu was formed several days prior to these fractal signals. This indicates that buyers are in control and a sell at $913.08 would not be justified. A sell below $908.01 makes more sense since it aligns with the support provided by the 50 percent level of the bullish Marubozu.

Setting limit orders near these fractal levels will allow us to take advantage of a breakout. Also examining the volume up to this point in time, we see that volume is falling. Once it starts to increase again, we see that the fractal level at $919.99 is breached. With limit orders, your trade would be automatically executed and the chart below shows that the market continued higher, following the path of least resistance. After breaking the fractal at $919.99, we see that the market formed a new fractal floor at $962.00.

Now we have determined how to use fractals, along with candlesticks and volume to enter a trade. How do we know when the underlying structure has changed. A simple way to know is to examine the down fractals, since we bought on the market breaking an up fractal. The chart below shows how to set stop losses in light of the structure of the market.

At first, our stop loss was at $908.01, the fractal stop. After buying at $920.99, the market continued higher and established a new floor around $987.01. Once this fractal is formed, we move the stop loss up from $908.01 to $987.01. If the market moves below this level, then the structure has changed, much like as if someone has manipulated the flow of a river.

Therefore, we look to lock in our profits at this level as we know an attempt below this fractal could cause a change in the structure of the market. However, the market continued higher and established several, successive fractal floors above $1000. So we continue to move out stop losses according to structure that is playing out in the markets, setting a stop loss around one dollar below the fractal level. This is important to maximize profit, as seen in the chart above, there were several fractal levels formed within one dollar of each other around $1004 and we could have been stopped out in our trade if we set the stop loss very close to the fractal level.

The market eventually established a down fractal at $1025.00 and this is when we exit the trade, as determined by the market, not us. Remember, we have to allow the market structure to unravel and align our personal underlying structure with that of the market. So we ride the structure, flow with the currents and catch the majority of the upward move. The market then turns below $1025.00 and we would be taking profit around $1024.00 with a limit order, so it executes automatically.

Understand chaos and the fractal nature of the market and you would have avoided panic selling when bitcoin was oscillating around $1004. This is what is meant by geometric harmony. You align your trading plan with the ever-changing structure of the market, exemplified by exiting a trade with the fractal method above. This also applies to entries into the market, which should be analysed and updated constantly.

Trading with fractals ensures you are trading in the direction of market momentum. Now, we know what a fractal is, we can identify when one may be forming, which can also help you prepare for moves in the market.

Identifying Market Trend With the Alligator

The fractals can be combined with the Alligator indicator to produce more reliable signals. The Alligator shows three lines, similar to moving averages, known as the teeth, lips and mouth. The Alligator’s Jaw, the “Blue” line, is a 13-period Smoothed Moving Average, moved into the future by eight bars. The Alligator’s Teeth, the “Red” line, is an eight-period Smoothed Moving Average, moved by five bars into the future. The Alligator’s Lips, the “Green” line, is a five-period Smoothed Moving Average, moved by three bars into the future.

When the lines are intertwined, close together and are not trending, this means we should be on the lookout for a breakout as the Alligator’s mouth is closed and he is said to be sleeping. As he sleeps, he gets hungrier by the minute, waiting for a breakout from his slumber when he will eat. When the trend takes shape, the Alligator wakes and starts eating. Once satiated, the Alligator closes his mouth once again and goes to sleep.

The Alligator indicates that market trend and confirm fractal breaks. Also, it can be used for entry and exit into trends.

For example, take a look at the chart below for ETH-USD with the Alligator indicator and fractal levels. Around March 23, the Alligator indicator started to intertwine, going into sleep mode. Therefore, at this point, we look for the most recent fractals and place limit orders. For example, a buy limit order at $42.10 and a sell limit order at $37.50. Since the Alligator is ‘asleep,’ a breakout is imminent.

Later on March 23, we obtain a breakout to the upside and the limit order would be trigerred. Now we wait for the Alligator to fan outwards before taking profit. On March 24 a new fractal level was established at the fresh high at $52.89. The Alligator is also spread wider, suggesting the Alligator will go back to sleep soon and the market movement will slow down and halt.

Therefore, we would look to exit as close as possible to $52.89. March 25 saw the market attempt to test $52.89 but only manged to get as high as $52.56, a signal to exit. Alternatively, we could hold onto the long position until the market closes below the Alligator signaling the end of the uptrend.

For example, see the chart of XMR-USD below for this method, which is simpler and abstracts from fractals. Notice, when the market closes above the Alligator, we look to buy XMR-USD. Alternatively, a close below the Alligator and we enter into short positions. We can also use the fact that the Alligator will act as support or resistance when exiting trades or use the formation of the Alligator itself, that is when it is starting to sleep.

Identifying Momentum with the Awesome Oscillator

One method to identify a shift in momentum is to wait for crossovers of the Awesome Oscillator (AO), from negative to positive for long positions and from positive to negative for short positions. Shown below is an example using the weekly price action for ETH-USD.

The strategy below is known as the Bearish Saucer. First, we need to confirm a downward trend with the Alligator. Then we look to the AO for bearish signal to indicate entry points. For example, the 4-hour price action for DASH-USD is shown below. A bearish saucer occure when the AO is in the negative region. We look for two green bars and then a red bar with the red bar lower than the second, green bar.

For example, we first obtain this signal on March 27. Once we observe the bearish saucer in the AO indicator, we look at the low of the candlestick corresponding with the red bar of the bearish saucer. So in this case it is $90.60.

Then we set limit sell orders at $90.59. In the following 4-hour session, the limit order is triggered and the trade is in profit by the end of that 4-hour trading session. We can hold onto this trade until the market establishes an uptrend, as indicated by a shift above the Alligator.

The bearish saucer signal is also given on March 29. Therefore, we would have set a limit sell order at $82.59. This trade would not have been triggered until the next day. Also, again on March 30, we observe another bearish saucer signal and we act on this signal by setting a limit sell order for $77.65.

Notice that the AO turned green on April 1, which may indicate that the downward trend is over and to exit the short positions. However, if you want to take a riskier exit option you can wait for the market to close above the Alligator.

Also, note that the inverse of the bearish suacer is the Bullish Saucer, occuring when the AO is in positive territory. An example is displayed below with XMR-USD on the weekly timeframe.

Notice that the exit signal has not been give yet, as the market remains above the Alligator, suggesting the uptrend is still in play. As this example shows, the Awesome Oscillator deserves its name.

Unravelling our Personal Underlying Structure

Now we have examined market structure, let us examine our personal underlying structure, necessary to attain the highest potential as a trader. If we succesfully understand ourselves, we can understand the composite of humans that form the market. A primary function of the market is communication, announcing to the public what is happening on a real-time basis. Williams then goes on to state that the three principles of human communication that are true for an individual are also true of the market.

90 Percent of Everything We Hear is Lies

Thought and brain patterns do not translate perfectly into speech. Limits in our vocabulary and knowlege of language may prevent us from effectively communicating our idea across to someone else. Thoughts and feeling are modified by desires, fears, and anticipation. As a result, pretty much everything that is said to us is a lie. That is not to say everything that is said to us is an intentional lie or an ill-conceived one. Rather, it is just highlighting the natural ‘chaos,’ covering up the parts of the world that do not agree with our paradigms.

Take for instance, when people say they do not understand something. “I don’t understand why you would do that.. I don’t understand this cryptocurrency market,” instead of understanding, the person saying these things are covering up their true thoughts. Understand is used as a replacement for control. So while someone saying this is communicating the word “understand,” if we dig deeper and look for the real message, we realize it revolves around control.

So how does this apply to cryptocurrency trading? Never assume what you are being told by analysts, popular personalities in the Bitcoin community, or even your best friend is true. Some lie intentionally to make money at your expense, but most lie without knowing it. Financial commentators are paid to talk and no one can know what is truly happening in the market, so any description of it is always going to be incomplete.

You Cannot Lie on All Channels

When communicating face-to-face, we observe light and sound. We look at the person when they are speaking and listen to what they are saying. This principle tells us that someone cannot lie on all channels, meaning that if they are telling you a lie, the person lying will display some clues either in their voice or body language and movement. For example, when many people lie they look to the right or look in a different direction.

The same with the market, but instead of light and sound, the two channels are price and volume. If price is rising while volume is declining, the market is lying on one of these channels. You then have to figure out which channel is being dishonest. But generally, volumes precede prices, so it would normally mean that price is lying and needs to move lower.

People Can Only Talk About Themselves

Everything we say is making a statement about ourselves, our nervous system, our thoughts, feelings and beliefs. For example, if someone says, “Look at that man/woman outside walking in the park, he/she is so attractive,” it does not say anything about the person in question, it only conveys what the observer thinks about the concept of beauty. As the saying goes, beauty is in the eye of the beholder.

How does this apply to the market? Well, analysts and commetators can talk about the market until you are sick and you will never get the real deal on what the market is trying to tell us. Only the market can talk about itself, not analysys or commentators, so we should “listen to the music and not the words.” How does we listen to the market?

Ticks. That is the movement of the price of the asset in question. Ticks, or the lowest unit change in the price of bitcoin, is the language of the market and will always tell us how the market feels.

Once we apply these principles to the market and treat it as an organism, and understand ourselves, geometric harmony can be achived and this is when you are in the top echelon of traders in the world. Most people never make it to this stage due to the ‘psychological pendulum’ and give up instead.

We move onto how we can examine our personal underlying structure. Firstly, your body structure has an effect on everything you do and there are three main body structures; Ectomorph, Endomorph, and Mesomorph. While no one is purely an ectomorph, endomorph or mesomorph, there will be one type or even two types that dominates your figure.

 

Endomorph is classified by the word bulk and is exemplified by round body shapes. People with this body type are generally sociable, find physical comfort to be important, need people in their life, and are honest with money. When drinking alcohol, they generally become jolly and friendlier. Endomorph’s respond to feeling comfortable in their body and their mind.

On the other hand, you have ectomorph classified by the word speed and is used to describe people who have lean and thin bodies. They tend to keep their emotions inside, prefer silence, have bad routines, desire security and are persistent people. When drinking alcohol they tend to want to sleep. Ectomorphs respond to feeling worthy.

Finally, mesomorph is the muscular body type, classified by the word strength. These people enjoy physical adventure, are energetic and bold, aggressive and competitive. When drinking alcohol, they generally like to fight. What mesomorphs respond to is stepping up to a challenge.

Different body structures are motivated by different stimuli. Your personal structure also affects how you process and respond to incoming information. Noting how your body structure affects your trading is important, as you want to be in an environment that will assist you, rather than hinder you. For example, a bulky, round-bodied trader might want to ensure complete comfort while trading; setup a large widescreen TV to look at charts, comfortable reclining chair, use of a mobile to execute trades and a place where their friends can visit.

On the other hand, an ectomorph will want to be in an environment where he feels worthy and that trading is worthy. Also, a silent and secure environment is ideal for people with these body types.

Then, mesomorphs might want to trade as they travel or go on adventures, seeing is as part of the journey, or perhaps alternate trading sessions with power exercises or team sports. 

Trading is Not Supposed to be Stressful; it is Meant to be Fun

The final point is to have fun. When having fun, this is when traders are most profitable. Remember, you trade your own belief system and if you are in the state of mind to create rather than solve problems, you can create your profits, as you alone decide when to enter, when to exit the market, how much risk to take and how much profit you want. Seek geometric harmony with the market, have fun and the profits will flow.