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Bitcoin Weekend Trading Action Was Good to Bulls, but Now What?

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This period of lower volatility is likely to end in a move up, but Bitcoin investors and traders should be ready for temporary moves lower.

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Today we saw another article on Bitcoin on the Wall Street Journal blog. The piece is on the three key challenges ahead of the currency this year. The post argues these challenges are regulation, adoption, and volatility.

Regulation is important since, as my firm has stressed, it will be interesting to see how governments react to Bitcoin and what regulations will be put in place. For now, eyes are on the Internal Revenue Service in the US and on any possible guidelines it may issue for Bitcoin.

Adoption concerns businesses that accept Bitcoins as payment for goods and services. Overstock.com (NASDAQ:OSTK), Zynga (NASDAQ:ZNGA), and TigerDirect (NYSE:SYX) have already made it clear that they will be accepting the currency. Small businesses all over the world are also taking advantage of this payment system. On the other hand, we're still waiting for more heavyweights to join the party.

Volatility is important both for the individual and corporate Bitcoin user, and for Bitcoin investors and traders. We've seen the currency go up to $1,200, only to go down to $600, then jump back up to $1,000. Traders and investors might profit from such volatility, but it also makes it hard for the currency to be a store of value and a reliable means of transferring money between countries.

It will be very interesting to see how Bitcoin stands up to those challenges in the near future. Now back to the currency itself.

On Mt.Gox, Bitcoin went up 4.8% yesterday on highest volume (btc 12,962.01) since January 9. This was a second day of relatively strong appreciation on increasing volume. The first more significant move turned out to be to the upside, and it took place over the weekend. Does this development make the future rosy for those of you who are long Bitcoin? Not necessarily.



Despite the move up, we haven't really seen Bitcoin move beyond the recent trading range based on $800 (our stop-loss level and the dashed red line in the chart) and $1,000-$1,100 (which coincides with the solid green line in the chart; yes, the currency closed Sunday above $1,000 but has since retraced). What do we make of this?

It looks like we're still in the range and no overly bullish conclusions can be drawn based on the recent action. Of course, it's better to be long after a move up than after a move down, but the fact that the situation played out nicely shouldn't make us too confident – it's easier to give in to emotions and make decisions under the influence of the moment.

Right now, we're still in the trading range and nothing has changed the outlook so far. Our bet is on this period of lower volatility to end in a move up, but even in such anticipation, we're ready for temporary moves lower. This might be the case today as Bitcoin is down 2.1% from yesterday's close at the moment of writing (before 8:00 a.m. EST). The volume so far (btc 1,664.10) has been indicative of a change in immediate momentum and a possible close below yesterday's end-of-day price. The fact that the move has been relatively weak compared with the recent appreciation and that the volume seems to have fallen doesn't make the short-term outlook bearish, in my opinion.

Question From a Reader

On Friday, my company received an interesting question I'd like to comment on at this time:

Q: I am waiting for someone to write an article on Bitcoin manipulation. When I think of Bitcoin, I think of Bre-X.

A: We're definitely looking into the subject, and it is possible that we'll make some of our research available through a special report or other kind of publication. For now, we only can say that Bitcoin is quite different from Bre-X in that it's not a company controlled by a board and there are no actual minerals involved. So, any kind of irregularities in the Bitcoin market would likely look different than what was the case with Bre-X (basically, overstating the amount of gold discovered).

Having said that, Bitcoin is still vulnerable because the system hasn't been around very long, let alone been recognized by companies and authorities. So, there is risk of Bitcoin theft and it seems conceivable that a single mining pool could surpass the "magical" barrier of 50% of mining power, which would make things messy by enabling transactions to be reversed.

It is also because of this kind of risk that Bitcoin is fascinating and potentially profitable. It is still a very young system without enough credibility and one that is still quite small. The whole question of if Bitcoin is a bubble or the new deal for online transactions can't be answered at this time, making Bitcoin a possibly very profitable investment, but also an extremely risky one.

We've previously mentioned that you should only put a small part of your portfolio in Bitcoins and we stress that once again. If you only invest in Bitcoin a small part of the money you can afford to lose, you won't be hurt if things go south, but also might be adequately compensated if things turn out just fine.

Summing up, the action over the weekend was kind to bulls but there have been no changes in the short-term outlook so far.

Mike is a quantitative analyst focused on economic reality, not theoretical models. His investment thinking is grounded in empirical evidence and common sense. A holder of two master's degrees in quantitative methods and finance, he researches economic uncertainty, portfolio management, and investor behavior. At SunshineProfits.com he develops innovative investment tools, and is the author of the Bitcoin Trading Alert service.
No positions in stocks mentioned.
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