It’s time to short bitcoin

Bitcoin price chart

It’s been a tumultuous few months for those speculating on bitcoin. To recap, we first suggested that bitcoin was overvalued when it was just below $5,000 a coin in mid-October (though we suggested that you wait until it fell before shorting it). We repeated this advice a fortnight later, and then again last month. Now, our bearish stance seems to have been vindicated. The cryptocurrency has fallen from a peak of more than $19,000 a month ago to just above $10,000 – a fall of around 45% in just a few weeks.

There are both fundamental and psychological reasons for the drop. On the fundamental side, governments are cracking down. South Korea plans to impose taxes of up to 24.2% on any cryptocurrency profits, and to ban anonymous trading; the US tax authorities are warning bitcoin will be treated as property for tax purposes; and China (which already bans bitcoin and the launch of digital currencies) has said that it will crack down on bitcoin “miners”, people who use their computers to create new bitcoins.

Bitcoin mania calms down

More importantly, the euphoria has receded. Indeed, many bitcoin sceptics, who had remained silent as it soared, are now coming out of the woodwork to warn of further falls. Goldman Sachs notes that “cryptocurrencies have moved beyond bubble levels in financial markets, and even beyond the levels seen during the Dutch ‘tulip mania’ between 1634 and 1637”. Of course, this change in sentiment raises the question of whether it is still overvalued, or whether we’ve left it too late to benefit from the bubble bursting. Indeed, after such a dramatic drop there’s always the temptation to bet on it bouncing back.

However, I’m confident there’s further to go. After all, $10,000 only brings us back to where it was at the start of December, and is more than twice the level it was when we started talking about it being overvalued. Also, when bubbles burst, history shows that prices can keep falling much further than anyone expects. For example, the Nasdaq fell by 75% between 2000 and 2003, while the Nikkei collapsed by 80% between 1990 and 2009. So I’d suggest that you short bitcoin at $11,225 at £0.25 per $1 with IG Index. You should put in a stop-loss at $15,255, and a “take profit” level of $4,000. This gives you a potential upside of £1,550 and a downside risk of £1,000.

Trading techniques… a simple momentum strategy

One popular approach to investing is to buy stocks that are rising and sell stocks that are falling – or momentum investing. Investors use a range of methods to spot momentum, including trend lines, moving averages and 52-week high/lows. However, one of the simplest strategies is to buy the shares that have gone up the most, and sell those that have gone up the least. While this may sound like a recipe for disaster, the evidence suggests that, at least in the short run, it works surprisingly well.

Academics Elroy Dimson, Paul Marsh and Mike Staunton looked at what would have happened had you bought the best-performing 20% of US stocks over the previous six months and held them for a further six months. They found that $1 invested in 1926 would have become $2.1m by the end of 2016 under a high momentum strategy, but only $3,634 if you had selected the worst performers. This works out at a difference of 7.4% a year. They found similar results for the UK over the past century.

This effect seems powerful, and also supports the old trading adage “run your winners and sell your losers”. But be aware that beyond certain timeframes the effect reverses. John Griffin of the University of Texas found that buying the worst-performing stocks over periods of between one and five years and selling the best performers would have beaten the market in both the US and UK. Also, these studies tend to ignore transaction costs – in reality, constantly turning over your portfolio every few months to stick with the best-performing stocks vastly increases your trading expenses, eating away at your returns.

How my tips fared

It’s been several weeks since the last update of my trading tips, and there’s been a lot of movement in that time. Spread-betting provider IG Group (issue 846) is now at 784p, which means our trade is now £427 in the black. Oil-services group Petrobras (issue 850) is currently at $12.25, making a profit of £552.50. However, the AA (issue 858) is currently at 156p, which means the trade is making a loss of £250. Car maker Renault (issue 854) is doing much better and is £441 in the black. Finally, commercial-property group Hammerson, which we tipped in issue 873, is at 499p, slightly below the level we bought it at, so it is making a small loss of £68. So overall our five long positions are looking good, on a total of £1,102.50.

Our shorts aren’t doing as well. Electric car maker Tesla (its Model 3 saloon is pictured) is trading at $351.56, substantially above the level at which we bought it last summer. Overall, the trade is sitting on a loss of £267. Facebook has gone up further since our last updates and the shares are now at $185.37. This means that the loss on the position now exceeds £500. As a result, our short positions have lost a total of £768.96. The good news is that our seven positions (five long and two short) are making a cumulative profit of just over £330.

The first thing we’re going to do is close out our two shorts. While I still believe that Tesla is wildly overvalued, after six months of going against the market, it’s time to move on. Similarly, my losses on Facebook are too large to sustain. While I’m going to stick with AA for the moment, it is close to being sold. I’m also going to adjust some of the stop-losses. Raise the stop-loss on IG to 671p, Petrobras to $9.43 and Renault to e87. This will lock in at least £200 of profit on each.