Recent Bitcoin Weakness Creates An Opportunity
Bitcoin, it seems, has rediscovered its volatility. After a couple of months of consolidation spent hovering around the $600 level the crypto-currency has taken a dive in the last week or so, losing close to 20 percent of its value. This may seem like a dramatic move to those more accustomed to the stock market, but to those familiar with the price action of Bitcoin over the last year this is well within the bounds of a normal trading move, as this 1 year chart from coinbase.com illustrates (see below).
There are several theories around as to what has caused the drop, but whatever the reason Bitcoin is close enough to the lows of early April to constitute an opportunity for those wishing to buy. To understand why, you have to understand something fundamental that I learned in my nearly twenty year career in the interbank currency markets.
To those who trade for a salary, exit levels are more important than entry levels. When your job is to trade you have to understand that no matter how convinced you are that a trade is right you must always accept that it can be wrong. In fact, assuming that it will be, and taking precautions to guard against that, is essential if you want to keep your job. Long term trading success is about limiting losses and avoiding the one big blow up that will sink you.
For that reason, proximity to a logical, easily visible stop loss level is often all the signal you need to go long. In this case, with Bitcoin trading at around $475 as I write, a stop loss to guard against a break below the previous $395 low, at say $390 would limit potential losses to around 18 percent. Again, to those accustomed to the more sedate moves of the stock market, that may seem huge, but in the context of past volatility it looks reasonable. That volatility produces an exaggerated upside as well as downside don’t forget, and just a bounce back to the $660 level achieved after that April low would represent a 42 percent gain. In other words, the risk reward ratio of the trade is in your favor.
Of course, none of that means anything if you don’t believe Bitcoin can rally, but I would suggest that recent news suggests that it can and will. According to a Wall street Journal report, Braintree, a subsidiary of PayPal and eBay is in talks with Coinbase and others about beginning to accept Bitcoin transactions, and Overstock.com’s CEO recently stated that he expects the company to be doing $1 million of sales per month in Bitcoin by the end of this year. Both of these things, taken together, point to an increasing acceptance of the currency and bode well for the long term future.
When Bitcoin does gain broader acceptance the very structure of it, with limited issuance, will give support to the price, as will its increasing use in developing nations where history has taught those of an entrepreneurial bent to be wary of currency issued by their own government. This is only logical, but caution is still advised. There is an old saying among traders that the market can stay illogical longer than you can stay solvent, so stop losses are a must.
I believe, then, that now is a good time to enter the fray. If Bitcoin weakness continues and you do get stopped out at $390 you will live to fight another day. If, on the other hand, the correction comes to an end and a bounce ensues you will be well placed to benefit from the long term upside potential.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.