Thursday, November 28, 2013

Bitcoin Is Making My Leg Tingle!

Remember when a certain propaganda pusher on MSNBC stated that Obama made him feel a tingling sensation run up his leg?  Thinking about the meteoric recent rise in Bitcoin exchange rates is causing me to have that sensation right now.  I'm not joking, and don't think I'm having a stroke.  It's just a manifestation of joy.  And I don't even own any Bitcoin, lacking the capital, time and spouse's permission to speculate in this medium.

I'm happy about the rise because it seems that a lot of the early and present holders of Bitcoin share certain of my beliefs about the superiority of voluntary institutions to coercive ones.  Hopefully, peace-loving people are going to be the prime beneficiaries of a speculative boom, instead of the military-industrial complex.  It's exciting to think about what all these peace-loving and creative people are going to do with their speculatively acquired purchasing power.  Some significant portion of them are going to divert economic resources into promoting development of voluntary society, and dis-empowering coercive institutions, even if only by living more independently of the state and spending their lives in more worthy endeavors than being tax slaves.  It's all good.  Hence the tingling.

All of this joy doesn't mean that I can't recognize a speculative bubble when I see one.  And Bitcoin is definitely experiencing a bubble right now.  Or so its price chart is screaming.  How high it will go, when it will crash, and at what price it will stabilize after the inevitable crash, nobody knows.  But holders of Bitcoin would do well not to ignore the classic signs of tulip-mania.

Bitcoin is unlikely to afford its holders the luxury of days or weeks to unload their coin after a top is established.   The market is still too thinly traded for that.  The available time will likely be measured in minutes or hours, and it may be impossible to find any buyers at a price you expect, if the price drops rapidly enough.  It's no fun being a seller trying to unload into a diving market.  To avoid being stuck holding all of the bag, anyone who has already realized significant profits by holding Bitcoin should have a plan to begin taking profits out now.  Not all profits, but some.  If you have already made large gains, take some percentage of your profits.  Say, 20% now.  And an additional percentage at regular intervals, if the price keeps going up.

Let's see how this works with an example:
Initial investment $10,000 to buy 100 Bitcoin at $100 each.
Bitcoin price at $1000: Coins held worth $100,000, sell 20, cashing out $20,000, 80 left.
Bitcoin price at $1300: Coins still held worth $104,000, sell 10, cashing out $13,000, 70 left
Bitcoin price at $1690: Coins still held worth $118,300, sell 8, cashing out $13,520, 62 left
Bitcoin price at $2,200: Coins still held worth $136,400, sell 6, cashing out $$13,200, 56 left.

You get the idea.  Take out a constant dollar amount every time the price rises 30% (more the first time because of the 10,000% price increase already experienced in this example).  You can adjust this strategy to suit your preferences.  The basic idea is that if the price keeps going up, your investment continues to grow in value.  If there is a sudden crash after a period of growth, chances are you will already have recovered your initial investment with a tidy profit. 

After selling your coin, you don't need to hold FRNs.  There are plenty of other assets you can hold instead; I recommend diversifying your holdings. Whatever you do, don't just buy and hold Bitcoin.  The market will likely punish you severely.  Bulls make money, bears make money, but pigs get slaughtered. 

Be prepared for the beginning of a prolonged downturn at any moment.  Use a technical analysis method to tell you when to sell, such as a crossover of a short-term average over a long-term average.  There are many proven methods; just pick one simple method and stick with it.  The primary benefit of technical analysis  is to take the emotion and mysticism out of trading decisions; there's nothing magically predictive about such methods.  All rational technical analysis methods will require that you endure a significant loss, for example 10-20%, before selling to avoid being "whipsawed" by market "head fakes."   It is impossible to perfectly time any market, except by pure random luck.

Suppose, for example, after reaching $2200 the market drops to $1760 (-20%) with no sign of stopping and your technical sell signal is triggered.  At that point, you must sell all of your remaining coin, receiving $98,560 for the sale.  Do not waver; just tell yourself you'll quickly buy back in if the price goes back above its high of $2200, which would be a strong signal that the downturn is over (or use whatever other technical buy signal you prefer).    Plus the prior sales, at that point you will have realized $158,280, or a profit of $148,280 on the initial investment of $10,000.  A stellar return.

You can then wait until the price stabilizes and starts to head back up before buying back in, if you want to continue to speculate.  A good strategy is to use a technical buy signal and start buying over time once the signal is generated.  For example, buy 10 Bitcoin per week until you own as many as you care to, once the technical signal is generated.  Hold for a while, and repeat as necessary if a second bubble emerges.

If you're out, should you get in now?  It's impossible to know, because no one knows how long the upward market pressure will continue.  But if you do just start getting in now -- and by "getting in" I mean buying more than you need for your normal business needs i.e. speculating -- don't do so without recognizing the risk, and having a trading strategy that will get you out in time.  Just because you believe like many others that Bitcoin has a bright future does not mean the price can't crash.  There are few examples of meteoric price explosions in any market not followed by a crash.  In fact, I can't think of any.  Bubbles are a market phenomenon largely unconnected to the virtues of the commodity being traded.  No one is being forced to buy or sell Bitcoin, so a market certainly exists and will behave as all markets do.

I'm not a licensed or qualified investment adviser, so take the above as just friendly and free talk around the libertarian water cooler for inexperienced traders who already invested in Bitcoin and are wondering what to do next.  The babble is worth no more than what you have paid for it, and all warranties are disclaimed except that it is given with good intentions by an amateur student of trading strategies.  Fare well.