Speculating on Bitcoin

The idea of speculating on something always involves an expectation of a profit. This is the reason why we speculate and the only reason, as this is what defines speculation itself, this expectation of gain.

Volatility is the potential for a trade to increase or decrease in value over a certain amount of time, the amount of movement that may be expected or tends to occur with something, and the more something may be expected to move in your direction, the more potential for profit there is.

Speculating on BitcoinVolatility involves both an increased potential for gains and as well as losses, and the potential loss side we call risk. It is all risk, and whether a certain move involves risk for a particular trade depends on what side of the trade you are on.

For instance, if you are long the instrument, risk to you in this particular trade anyway involves the risk of the price decreasing, although if you were short it you’d see risk as the price increasing.

Instruments tend to go both up and down to various degrees, involving these risks, and we call this tendency the volatility of the instrument, which we measure as a matter of its tendency to go both up and down, it’s potential ranges over time in other words.

When we speculate on something, things that are more volatile tend to excite us more and have us wanting to speculate on it more, or at least this is the case with a lot of traders, who perceive this higher volatility and want to seek to take advantage of it.

This has traders who seek to speculate gravitating to trading things which tend to move more, as they seek to capture larger gains with their trades. This only makes sense really because if you can choose between two instruments, one stable with limited profit potential, and one with more volatility, there’s going to be more potential with the more volatile one.

Since the goal is to maximize profits, higher volatility will naturally attract more speculators because there is more to speculate on. This is certainly the case with speculating on Bitcoin.

Where There Is Volatility, There is Also More Risk

This is not the only consideration in seeking to choose instruments to trade though, as the more potential for profit there is on one side of the trade, whether long or short, there is also a similar potential for profit on the other side of the trade.

Volatility involves the prices of things going in both directions in greater magnitude, and there is perhaps no more poignant example as the movement in Bitcoin in 2017 and early 2018, which is the time of this writing.

While Bitcoin was originally designed as a currency, it ended up evolving into essentially a commodity, like gold for instance. The price of gold and other precious metals can double its value or more, or lose half its value or more, over a period of time, generally several years, but Bitcoin ended up redefining the amount of volatility we can see with a commodity, to degrees many times what we have ever seen in modern times.

It’s not even the fact that Bitcoin rose so much over the last while, for instance increasing 20 fold over the period between April and December of 2017, for roughly a 2000% gain over three quarters, it is how much it has moved up and down during this time, including it giving back half of its value in the month after its December high.

Bitcoin is so volatile that it has the potential to move 10 to 20% in a single day, and even more modestly volatile days will see its price move around 5%. This is simply a phenomenal amount of volatility, and while there have been several huge trends in the price of Bitcoin over the last couple of years, even its intraday swings are huge.

The volatility of Bitcoin is so high that it simply dwarfs anything we’ve ever seen in financial markets that aren’t cybercurrencies.

Precious metals used to be the king here, gold, silver, platinum, and palladium, and all have seen some pretty big swings. Silver in particular saw a huge spike when the Hunt Brothers became very heavily involved in the market, which saw the price quintuple over a period of about a year, and then it gave it all back over the next two years.

Bitcoin’s volatility is such that it’s the Hunt Brothers type of market full time, not just a one off, and the magnitude of Bitcoin’s volatility is several times larger than even the most extreme market conditions that we have seen in the past.

With this extreme volatility comes extreme risk, as the two go hand in hand. If someone bought Bitcoin at its market top in December 2017 for instance, with the expectation that it will only keep going up, they would have seen half of their position evaporate by mid-January 2018.

Those who had bought earlier at a lower price and held during this decline would have had to endure seeing their position lose half its value over this time as well, and while they still may have booked some serious gains even with that happening, others may question the wisdom of holding on through such a severe downturn.

With Higher Volatility Comes the Need To Manage Risk Better

We tend to like the higher profit potential of an investment or trade while disliking all the extra risk that this higher profit potential brings. Many people only look to pay attention to the profit potential side and end up giving managing the risk side of these trades shorter shrift than it deserves, or maybe not even pay attention to it at all.

Ideally, we want to give both the potential and the risk the attention they deserve, and the risk side deserves even more attention, as it hurts more to lose than it helps to gain as a general rule. You can buy a nicer shirt if you gain but if you lose your shirt you will now be shirtless, which is worse.

There has never been an instrument traded on financial markets that is more in need of risk management than Bitcoin and other cybercurrencies, and nothing comes remotely close. This does not mean that this tremendously higher amount of risk cannot be managed, and it surely can, and can be managed pretty well, but not by seeking to ignore it or not giving it enough attention.

Successful trading is something that many can pull off, those skilled and experienced enough, but most people underestimate the amount of skill involved. This skill is for the most part centered around proper risk management, not just picking trades, going long, and crossing your fingers, and not knowing what to do when things don’t go the way you planned.

This describes most amateur traders pretty well, sadly enough, and it results from entering trades without either an advantage or a solid plan to deal with whatever happens in the trade. In particular, this involves recognizing when the trade is going against you along with the discipline to exit it whenever these conditions manifest.

Many people have come out to warn potential traders in Bitcoin about the pitfalls of trading it and all the risk involved, but these people don’t really get it either, they assume that the only course of action in a trade is to go long over the longer term with no real risk management involved, and they are most certainly correct that this is a horrible idea with something like Bitcoin.

It’s not that this is ever that good of an idea anyway, as this involves ignoring proper risk management, buy and just hold. With something as volatile as Bitcoin, such a strategy is many times worse, because the risks that you are ignoring are much larger.

Speculating on Bitcoin With a Plan

It is not that one cannot be successful speculating on something without a good plan, for instance there are people who may have bought it back when it could be had for just a few hundred dollars and may have just chosen to hold on to it indefinitely, with no exit strategy, and would still show a very good return even if it loses 90% of its value from its recent peak.

We may wonder though why it would ever make sense to hold something to that point where it gave back that much, especially when trends become very obvious. The reason is that a lot of traders simply base their decisions on hope. They buy hoping the trade will be successful, and while their hope may wax and wane depending on market conditions, they continue to cling to it, and hope it will go back up even when it has gone down a huge amount.

Hope is not an objective condition though and the market does not care about our hopes, and to be successful, it is far better to base our trading decisions on things more concrete, how the market is behaving.

Bitcoin has gone through a very wild ride lately, but it’s not that this journey cannot be tracked, and we can use various timeframes to do it. The fact that something is more volatile does not necessarily make it more difficult to track, and often more volatile instruments are easier to predict, if we use the proper tools and perspectives.

For example, if we look at weekly bars of Bitcoin using a stochastic momentum indicator for instance, we can see an entry in early October 2017, and the indicator pointing downward in the week after the top in December 2017, allowing us to enter at around $5500, exit 2 months later at around $17,500, and take the opposite direction and ride the price down to $10,000, where it is at the time of this writing.

Buying and holding would have produced an almost doubling of your return in 3 months, which is pretty phenomenal, but using such an indicator can allow you to profit much more, in this case increasing the gain from $4,500 per Bitcoin to almost $20,000, and perhaps more importantly, much better ensuring that we are on the right side of major moves instead of having to just remain in trades and suffer whatever pain comes.

This is just an example for illustrative purposes, and just one of many indicators that could have been used to look to time this market. Some traders use weekly charts such as this, some use daily ones, hourly ones, or even minute by minute bars, depending on their strategies and how long they wish to be in trades on average.

The main idea here is that we got in when the momentum was crazy to the upside and shorted it when people started to take profits as well as exiting their positions for other reasons, meaning that the momentum had reversed. This is usually not that hard at all to see on charts and while it is unusual to get out this close to the top of an upward momentum wave in something so volatile, by seeking to be for the most part on the side of where the momentum actually exists, this can add greatly to our results if executed with the proper amount of skill and understanding.

This is an example of a trading plan, but just one, and there are many such plans that can be devised, but unless we do have some sort of plan, we’re just leaving ourselves exposed to the wind of the market, and the wind changes direction often. It is better to seek to ride the wind than just have any amount blow against us and even blow us down.

When the winds blow as hard as they do with Bitcoin, having a good trading plan, and especially a good exit strategy, is of much more importance. We have ideas about why we should enter trades, and we always should have ideas about when it is time to leave. This is called managing risk, which is always important.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

Contact Andrew: [email protected]

Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.