Hold your nerve over bitcoin

Isaac Newton © Alamy
Isaac Newton: hurt by gravity

My last column suggested that the digital currency bitcoin was overvalued and due for a fall – but also that you should wait until it had fallen back a bit before actually shorting it.

The latter strategy proved sound as bitcoin continued to surge, not only breaking the $5,000 barrier but also briefly surging past $6,000 for good measure. At the moment it trades at around $5,680. However, fans of the digital currency should be wary of seeing this as some sort of vindication. There have been many cases where an asset price has reached seemingly ridiculous levels, only for it to surge even higher.

Indeed, the trick in these sorts of situations is to keep your nerve, and above all resist the temptation to be sucked into the hype. During the South Sea Bubble of 1720, Isaac Newton made a handsome profit from selling his shares in the company, only to see his friends who hung on to their shares make large paper profits as the price continued to surge. Eventually, he got so frustrated that he plunged in again, only to lose huge sums of money when the bubble finally collapsed.

In any case, bitcoin’s reckoning may come sooner rather than later. The community is becoming increasingly  divided about how the currency should be run, particularly the process of “mining” bitcoins. At the moment new bitcoins are allocated depending on how many transactions a miner helps process.

However, many are complaining that the process favours professional miners who are able to spend large amounts of money on dedicated computer processing power. In an attempt to democratise the bitcoin production process, a faction has recently launched a new currency, bitcoin gold, using a different approach that favours ordinary computers.

This may seem a rather obscure dispute, and I don’t really have a strong view either way. But the main point is that this sort of split could very easily undermine confidence in the crypto-currency, both for investors and users. After all, the whole selling point around bitcoin was that it was run on supposedly “objective” lines, rather than subject to the whims of a politician or central banker.

Once you take that away, then bitcoin loses a lot of its attraction, and you might as well put your money in a normal currency. I’d therefore suggest that you keep a stop-order to sell bitcoin at £1 per $1. However, I’d adjust the price at which it is triggered from $4,100 to $4,500 in line with a 50-day moving average. This means that the trade will only be triggered once the price falls under $4,500. I’d also increase the stop-loss on the trade to $5,300.

Trading techniques: Elliott wave theory

A more offbeat alternative to trend lines and moving averages is Elliott wave theory, developed by accountant Ralph Elliott in the 1930s. He posited that markets follow a predictable pattern of a five-stage upwards trend, followed by a three-stage correction.

In the first wave, prices start to rise despite negative news and sentiment. However, the negative mood drags them back down, though not to their original level. That is wave two. Sentiment then improves leading to a rally that surpasses the peak of wave one. Wave four sees another, gentler retreat. By now sentiment has turned extremely bullish with many investors initially reluctant to invest piling in. As a result, there is another rally in the fifth wave pushing prices to new highs.

The downtrend is the reverse of the uptrend. It begins with a slight decline against a backdrop of positive sentiment, which ends up being largely reversed by a rally, leading many people to see it as just another part of the bull market. However, this then gives way to another, much larger fall, as sentiment becomes increasingly bearish.  By the end of the third downward wave everyone is convinced that a bear market is taking place (ironically just as it may be ending).

The problem with Elliott wave theory is that it is extremely subjective. One Elliott wave theorist may believe that a share or index is in an uptrend, while another thinks the opposite. So it is very hard to devise a test of whether the theory works. Yet it has many supporters, including legendary hedge-fund manager Paul Tudor Jones.

How are our tips doing?

It’s been a mixed fortnight for our recommended trades. As far as our five long positions are concerned, IG Group (Issue 846), Petrobras (850) and Renault (854) have all fallen slightly.

However, Barclays (856) has rallied a bit and the AA (858) has pretty much stayed the same. Despite these small fluctuations, IG Group, Petrobras and Renault remain in the black, while Barclays and AA are in the red. The net effect of all the movements up and down has been to slightly reduce our ongoing profits from £169 to £137, so there has been no significant change.

Meanwhile, it’s been a better time for our two short positions – or at least one of them. Up until now, our recommendation that you bet against Tesla (854) would have cost you £500. However, the fall in Tesla’s share price from $356 to $342 would have cut those losses by £150 to £351.

Facebook (Issue 864), which we’ve been shorting for the past four weeks, has essentially stayed the same. Overall, we’re losing £214. While this isn’t ideal, it’s not too bad given the profits that we’ve banked from trades that we made earlier in the year.

As a result, we’re not going to make any sudden changes to our portfolio by closing any of our open trades. While it’s nearly six months since we tipped IG Group, I’m still confident that the impact of the ongoing European regulatory review of the rules governing the spread-betting sector will be much less serious than people are anticipating. I’m still positive on the stock.

Similarly, I’m confident that increasing competition, production problems and higher-than-expected costs related to the release of the Model 3 will start to take its toll on Tesla’s stock price. I would therefore suggest you stick with the Facebook and Tesla shorts.

  • Zacalicious

    I’d think holding onto the old outmoded fiat system of banking is the bigger risk.

    It’s like saying “this newfangled automobile” is a bubble” and “we should stick with horses because they’ve worked for thousands of years”.

    Bitcoin is not a commodity, it’s a new technological process, that replaces no less than two obsolete models.
    The store of value found in gold is replaced and augmented with a transferability function superior to fiat money transfer by orders of magnitude.

    Market pressure will drive people to the more efficient model that offers greater value.
    The competitive pressures in the marketplace are so fierce, at this point, nobody can afford to give up the competitive advantage Bitcoin offers.

    People will adopt Bitcoin not because they “believe” in the ideology behind it, but because those who don’t will be left impoverished and have to adopt it eventually.