01 novembre 2018

Bart Simpson Pattern – Inefficiencies in Crypto Trading

Maximilian Boelstler

Maximilian Boelstler

Research Assistant chez Crypto Finance AG

A propos de l'auteur

How has Bart Simpson managed to weasel his way into cryptocurrency analysis? What possibly could the connection between cryptocurrency pricing and a fictional yellow character from the American TV series The Simpsons be? Talking with the trading experts at Crypto Broker AG, who analyse bitcoin charts, and with our further research in the area of trading patterns and trend analysis, we suggest a different significance behind this price chart pattern – all jokes aside.

Thanks to a little ingenuity and some inspiration from highly reliable, albeit satirical media sources, a recognisable chart pattern, known as the Bart Simpson Pattern, can be used to explain the recent inefficiencies in cryptocurrency trading.

So, what is happening?

The Bart Simpson Pattern occurs when an unexpected spike (or a drop) in prices is followed by a sideways movement, and subsequently by a sudden drop (or a spike) in prices. The chart pattern takes on the shape of Bart Simpson’s head.

Bart Simpson Pattern on Price Chart
Figure 1 – Bart Simpson Pattern on Price Chart

And why is it worth taking a closer look at the Bart Simpson chart pattern?

One enticing thought is that even though the cryptocurrency markets are becoming more professionalised, the possibility of price and market influences still exist. They manifest in the Bart Simpson Pattern. Inexperienced market participants are causing a great deal of these inefficiencies, which could easily be mitigated, e.g. by the use of appropriate brokerage services.

Allow me to explain by going more in depth.

The Bitfinex chart above (Fig.1) shows a BTC/USD price development. Several common market fluctuations are visible without any apparent abnormalities. Generally, a massive green (or red) candle will introduce the typical (or inverse) Bart Simpson Pattern. Upon closer inspection, at least two Bart Simpson Patterns can be made out in Fig.1: an inverse Bart starts on September 8th, with the end of the formation already beginning to form the second Bart Pattern. Images of Bart Simpson’s head have been inserted into the corresponding periods.

Ever since the beginning of 2018, both the variety and frequency of Bart Patterns have increased. When asked about price patterns in general, American financial market analyst John J. Murphy explained: “Price patterns are pictures or formations, which appear on price charts of stocks or commodities, that can be classified into different categories, and that have a predictive value”.

Despite the fact that cryptocurrencies and crypto assets came after his time, it also goes without saying that this research paper in no way constitutes financial investment advice nor will it offer any predictive value.

Returning now to Murphy’s definition, research has shown that the Bart Pattern may vary in its volatility, duration, and frequency. The formation usually occurs over a period of a few hours, apparent on intraday charts with a scale of 15-minute intervals. In Fig.2, which shows a close-up of the same two patterns depicted in Fig.1, the inverse Bart Pattern is visible in the significant increase in trading volume and significant decrease in price. In total, the price drops here for a period of approximately two hours. Subsequently, there is a kind of consolidation phase characterised by prices moving very little over a 15 hour period (the so-called accumulation area), after which an unexpected price increase takes place. The typical Bart Pattern that follows after that could be described in the reverse.

Zoom-In Bart Simpson Pattern
Figure 2: Zoom-In Bart Simpson Pattern [1]
As shown in Fig.2, a price cycle will generally contain the following phases: accumulation, markup, distribution, and markdown. However, a common price cycle is not characterised by an extremely steep markup and markdown curve as seen in a Bart Pattern. Moreover, a complete price cycle may last for a few hours, days, or months. A theoretical price cycle according to renowned stock market authority Richard Wyckoff is depicted in Fig.3.

Wyckoff Price Cycle
Figure 3 – Wyckoff Price Cycle

Here, the accumulation area is characterised by a sideways movement with the price moving relatively slowly. This phase is also referred to as market consolidation. During the late stages of a bear market, in particular, many investors try to trade during the accumulation phase in order to catch the bottom of the trend. Nevertheless, it is also possible for the bears to win, and a further downward trend will follow. Once the resistance level of the accumulation phase is exceeded, the markup phase will then begin. In this context, new highs will be set, or in the case of the Bart Pattern, an exceptional new high will be set in a relatively short period of time. Usually, the markup will last longer than the accumulation phase. At this point, investors of all kinds are attracted to invest, in the hopes of making profits during the upward trend.

As soon as there is resistance and the market faces a correction or pullback, the distribution area will start. As in the accumulation phase, the bulls and bears will battle against the upcoming movement. This means that the distribution area does not necessarily allude to a price drop. If selling volumes increase regardless and buying volumes decrease, it is only a question of time before the resistance level is exceeded and the price will drop in the markdown phase until the next accumulation phase is reached.

Richard Wyckoff, who founded The Magazine of Wall Street, was a pioneer in technical stock market analysis. He based his trading strategy on three laws, with the intent of identifying the best markets to trade and the potential future directional bias for prices. According to his “Three Wyckoff Laws”, the price chart can be affected by:

– Supply and demand
– Trading volume and the corresponding price change
– Duration of accumulation and distribution period

Is There a Reason for a Bart Simpson Chart Pattern in Crypto Markets?

Research has shown that the conditions under which the Bart Simpson Pattern seems to appear is if price movements were not apparent before the formation started, although trade volumes increased. This assumption may be in line with one of Richard Wyckoff’s trading theory laws. Talking with the trading experts at Crypto Broker AG, analysing bitcoin charts, and conducting further research in the area of trading patterns and trend analysis, I concluded that the Bart Pattern is due mainly to liquidity issues.

To create an overview of the relationship between market liquidity and the corresponding price developments, I attempted an historical reappraisal of an inverse Bart Pattern (cf. Appendix A). It is possible to divide its development into the following six steps

1. Trade Initiation (Sell Order)

Firstly, a larger [2] selling (market) order needs to be issued to initiate a corresponding and considerable price movement. For instance, the bitcoin price may already have moved by 2% with a market order of 500 bitcoin on a smaller exchange. Due to the possibility of initiating a relatively large selling (market) order for bitcoin – for whatever reason – the market may be faced with a liquidity problem.

From an economical point of view, the market supply of bitcoin exceeds the current demand and consequently the supply has exerted downward pressure on the bitcoin price due to the surplus.

2. Trade Execution

If the market (S0) does not have enough supply or liquidity and one relatively large order is placed that cannot be easily satisfied by the corresponding exchange platform, the order books will be completely stripped out. When an exchange is faced with an oversized price shift, every single buy position below the current trading price will be accepted without any restrictions, particularly with a market order.

As a result, the trading price is pushed down instantly until the trade is fully executed (D1). The left side of an inverse Bart Pattern is now visible. When the bottom is reached, the market starts to consolidate and so the sideways movement begins.

3. Accumulation Phase

Now, we enter the accumulation phase. Here, the market has reached its new equilibrium, meaning that the open orders were satisfied and the market will consolidate until S1 = D0. There is now also a new price (P1).

4. Trade Initiation (Buy Order)

As soon as a larger buy order is issued, leading to a breach of a higher resistance level, the probability increases that the bitcoin whales[3] will re-enter the market. By using their relatively large trading volume – in this case to execute a long position – the whales’ direct impact is reflected in the chart in an unexpected spike; and the second part of Bart’s head begins to appear. However, there is no shift in supply, only an unusual shift in demand (D0 –>D1).

5. Trade Execution

Because of the resulting demand surplus, the price is pushed even higher because there are not sufficient bitcoins available for the price offered. Similar to the previous trade executions for sell orders, every single sell position above the current trading price will be accepted without restrictions. Thus, the trading price is pushed even higher until the trade is fully executed (D1).

6. Distribution Phase

Subsequently, the distribution phase starts. As described in the accumulation phase, the market has reached its new equilibrium. The difference now, however, is that the balance is found at S1 = D1 with the new price (P2).This price could even be the price P0 from the beginning of the Bart Pattern.

The description above would be the same for a (non-inverse) Bart Simpson Pattern if steps one through three were to be changed to four through six, and vice versa.

Market Liquidity plays an Integral Role in the Markets

As a general rule, if there is sufficient market liquidity, most goods and services can be traded without there being any unexpected impact on their prices. Conversely, this implies that a lack of market liquidity could affect the prices of the traded goods, as shown in the example of the (inverse) Bart Simpson Pattern.

Both the upward and the downward move could be caused by a lack of liquidity. For the downward move, the lack of liquidity stems from too large of a supply that cannot be absorbed by the market. For the upward move, the lack of liquidity can be due to an increase in demand that also cannot be met by the market.

In the bitcoin market, two parties could be bitcoin whales and therefore capable of entering a relatively large order. On the one hand, there are institutional investors with the financial means to take influence on the market. On the other hand, there are many retail (private) investors who have an unusually large amount of cryptocurrencies, e.g. due to early participation in the crypto markets. In either case, one of them may represent a whale and thus be able to initiate such a trading pattern from the buy or sell side.

What is the intent of such an order beyond it simply being large and inadvertently burning money?

There are two explanations: either this is a retail investor without the necessary trading knowledge to execute a smart and smooth trading order; or the trade has been submitted intentionally by someone with a professional background. Speaking rationally, however, a large market order is completely inefficient because of the resulting financial loss. Both situations are therefore unusual in liquid traditional markets.

There is no proof that liquidity problems are entirely responsible for any Bart Simpson Pattern. There are, of course, examples where a Bart-like downward move was followed by a second downward move, forming a stair rather than a Bart Pattern. Yet, the great majority of Bart Patterns may be caused, and moreover explained, by liquidity issues.

Do Bart Simpson Patterns Also Appear in Traditional Markets?  

Yes and no. Since the beginning of 2018, the cryptocurrency market has faced a downward slide. In January 2018, its market capitalisation exhibited an all-time peak at approximately USD 800 billion. Through the following months, a steady decline in the market capitalisation became apparent. On October 23, 2018, 54% of the market capitalisation of approximately USD 209 billion was attributed to bitcoin. This is comparable to the market capitalisation of a single larger listed company such as McDonalds, IBM, or SAP. In short, it is difficult to compare a traditional market to the cryptocurrency market currently – not only because of its market capitalisation, but due to the market participants and emerging regulation.

A market that enables its participants to initiate relatively large orders also provides the greater possibility of prices being influenced. In the case of bitcoin, retail investors can enter these orders in the absence of regulation (be that through brokers or on exchanges). Whales are not just a factor in the bitcoin market. They also dominate the equity market, but there they are more likely to be institutional whales in a regulated environment. Thresholds to entry and related infrastructure in cryptocurrency markets vary significantly when compared to traditional markets. The execution of trades are carried out in an appropriate and more rational manner in traditional markets. Also, in traditional markets, so-called circuit breakers and other security mechanisms are implemented, as is apparent in the S&P 500 Index. As soon as a market or a single stock drops a predefined percentage within a predefined timeframe, a circuit breaker temporarily stops all trading on that exchange.

Crypto Finance AG, through its subsidiary Crypto Broker AG, is a financial intermediary available to qualified and institutional investors. This team of experienced investment bank traders draws on the liquidity of the world’s top exchanges to offer optimised order execution, without affecting prices, thus avoiding Bart Simpson Patterns.

Download the Bart Simpson Trading Pattern Research Article as a PDF

 

[1] Figure 2 includes the price development charts of Coinbase (red) and Binance (orange). It clearly shows that not only one exchange is faced with a considerable price drop and spike.

[2] Measured relative to the common trading volume during the last 24 hours

[3] Bitcoin whales – holders of large amounts of bitcoin

 

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