Cryptocurrencies can be extremely volatile, making it difficult to know the right time to buy, hold, or even offload stakes. While traders use several technical analysis tools to identify ideal entry and exit points, very few provide accurate insights about market sentiments. However, Reserve Risk Indicator by Glassnode is one indicator that could be relied upon to understand the prevailing market sentiments depending on price action.
What is a Reserve Risk Indicator?
It is an indicator best known for measuring the risk-reward ratio of an underlying cryptocurrency under study. While trading Bitcoin, the indicator would provide insights on the amount of risk an investor is likely to absorb depending on the underlying price and the reward up for grabs.
The indicator is based on what long-term indicators are doing in the market. It measures the risk-reward balance based on the confidence and conviction of long-term investors. Whenever a coin is not being spent, it is assumed that accumulation occurs and that investors are holding tight and not selling in anticipation of a price bump.
The chart above shows that buying opportunities emerge whenever the Reserve Risk indicator moves up after bottoming from lows. There is usually a high holding of Bitcoin or any other token under study at low levels. This is also followed by low spending on the underlying tokens.
The accumulation that takes place, in this case, acts as a buying pressure that helps steer the underlying price higher. However, it is important to note that a cryptocurrency could remain in the accumulation phase without strong price movements to the upside for some time.
In contrast, during periods of price appreciation, the incentive to sell increases as investors look to take advantage of significant price jumps. During periods of strong price rallies, the Reserve Risk indicator also increases.
During periods of high moves up, the long-term investors will resist the temptation to sell their holdings in anticipation of further price gains. Whenever holders refute the temptation to sell, the opportunity costs increase. However, it reaches a point of strong resistance where the indicator corrects and starts moving lower, signaling long-term investors have started offloading their stakes.
The Reserve Indicator compares the incentive to sell and the strength of the holders who refuse to sell. Therefore it tends to oscillate up and down as the price also fluctuates.
Buy signal
When the indicator is moving down, the risk-reward ratio is considered attractive in the market. This implies that conviction among long-term investors is high and that the price of Bitcoin or any other coin is attractive. Consequently, traders can use this opportunity to eye long positions on Bitcoin or any other coin under consideration.
Whenever the Reserve Risk ratio is below 0.0026, it implies undervaluation has kicked in the market. Conversely, traders can use this opportunity to look for potential price reversals to the upside. Nevertheless, periods of undervaluation can be relatively long, and prices can remain at subdued levels before bouncing back.
A Low Reserve Risk reading is often associated with undervaluation in the market, indicating that a potential price jump is likely to happen. The indicator will remain subdued at a low level until the price increases significantly to a level with sufficient incentive to cause holders to offload their stakes.
The Reserve Risk will always flirt with low levels whenever there is strong investor accumulation on a cryptocurrency. The low readings imply strong convictions among long-term investors to continue holding their tokens rather than spending in anticipation of a price jump. Therefore the risk-reward will be favorable in this case, acting as an attractive buy signal to catch the dip.
However, it is important to note that the Reserve Risk could hover in the green zone or low levels for prolonged periods. If this were to happen, the transition from the bear to the bull market would be slow. Therefore it is important to be extremely patient while tracking the indicator’s movement as it could remain at low levels for a while.
Sell signal
Likewise, caution is of utmost importance whenever The Reserve Risk is high and the indicator is rising. This simply implies low holder conviction in the market. Consequently, the unspent opportunity costs are decreasing, and the price of the underlying coin is high.
When the indicator is moving up, it shows an unfavorable risk-reward is creeping into the market. Consequently, it could mean that long-term investors will soon start selling, sending the price lower.
In the Bitcoin Reserve Risk chart above, the Bitcoin price corrected and started moving lower whenever the Reserve Risk indicator peaked. A higher Reserve Risk reading implies a strong incentive to sell as traders use this opportunity to lock in profits on Bitcoin price increasing significantly.
Consequently, Reserve Risk rallies will always imply mid to late bull runs in the markets. Therefore technical analysts use this opportunity to eye short positions as the prospect of price correcting and moving lower is usually high.
Periods of overvaluation kick in whenever the Reserve Risk ratio is above 0.0200. This implies that the price of the underlying cryptocurrency is likely to contract and move lower as buying pressure starts to ease. It mostly happens when the price has moved up significantly such that there are no new bulls to sustain the price higher.
Final thoughts
Whenever the Bitcoin price increases, the Reserve Risk will also tend to trend up. However, with prices moving up significantly, the incentive to sell starts to kick in for different holders. The indicator will move lower when the conviction to sell is strong enough, affirming more holders are using the opportunity to lock in profits.
Likewise, as Bitcoin price tanks, undervaluation sentiments tend to kick in. With the Reserve Risk deep in undervaluation territory, buyers often stream into the market looking to take advantage of the depressed prices. As the indicator starts to raise signaling accumulation, Bitcoin price will also start to trend up.