In just one month the cryptocurrency giant Bitcoin ($BTC) made strides as it appreciated in value by 41% from $4322 to $7382. As cryptocurrencies continue to draw more interest from investors and skeptics more economists are turning towards trying to understand the role the new asset class plays in the current market, and just how should analysts go about trying to understand price movements.
Traditional analysis for any exchange traded asset primarily consists of technical and fundamental analysis. An equity share is such a multifaceted instrument, with so many variables contributing to market pricing, that fundamental analysis is more of an art of juggling company performance and global macroeconomic conditions that gives one a good enough perception of the company’s standing. Technical analysis gives us insight of how past performance and established trends help us forecast future performance.
Cryptocurrency has proven to be a completely different animal.
Technical analysis is limited – extremely limited – when it comes to working with Bitcoin. It has been difficult to monitor volume of trades, short-term prices are subject to cross-exchange arbitrage, support and resistance lines are hard to identify, and demand continues to increase. In examining market announcement responsiveness TA is helpful only to a degree of establishing the price vector. While Bitcoin fundamental analysis mostly consists of asking the following question; Is there anything new in block-chain technology and is China onboard?
Despite few traditional variables at play, Bitcoin pricing brings about echoes of Keynes’ Castle-in-the-Air theory, suggesting that psychic values and behaviour drive farfetched price speculations of Bitcoin’s future intrinsic value.
Remember the first real price hikes that brought a wow-factor to the cryptocurrency market? Bitcoin investors are still chasing that original high, and the market is still not disappointing. Bitcoin investors establish their own psychological levels of support and resistance in the market which are primarily rounded to the nearest thousand of whatever quote currency. For the average bitcoin investor, it’s all about having their news feeds explode with “Bitcoin trades at $ X000,” and most never realize their gains because the currency fails to show any real sign of correction. Buy and Hold is the consensus of the entire market despite the fact that most people do not know what Bitcoin can be used for in the future, and whether those uses are compatible with the asset’s actual volatility. Essentially, cryptocurrency pricing is for the most part backed by behavioural-economic heuristics like anchoring, overconfidence, and FoMo (fear of missing out) or “Keeping Up With the Joneses” – theory of utility being set relative to your peers (that probably already invested in Bitcoin before you).
From a professional standpoint, three different trends are emerging insofar as Bitcoin trading is concerned:
A: Exchange Arbitrage: Analyzing price movements across different Bitcoin platforms, making use of varied spreads, and buying at undervalued levels.
B: Event-Driven Scalping and Day Trading: Using traditional technical analysis instruments focusing on short-term movements and holding periods linked to specific events. However, in recent weeks Bitcoin is starting to look less and less like a traditional asset class and no longer optimally conforms to these type of strategies, so many traders simply focus on trying to capitalize on post-announcement drifts.
C: Buy and Hold with Automation: This strategy involves setting very strict buy-limit orders for when the price drops, buy-stop orders set to recognize momentum, stop-loss limits, and take-profit limits for controlling unrealized gains. Many traders choose to this kind of trading with crypto CFDs.
Cryptocurrency is about to get another boost that will warrant more growth, with CME Group’s introduction of Bitcoin Futures before the end of 2017. This breakthrough for Bitcoin will allow traders to pursue alternative investment strategies and diversify their portfolios all under regulation by the Commodity Futures Trading Commission. Liquidity should be seen to increase with HFT, and bearish investors will be given more opportunities to test their metal. Additionally, investors will be able to hedge their cash risk with cryptocurrency futures. Ultimately, the bottom-line is:
“(Bitcoin Futures) will give people the ability to participate in a product on a regulated platform that they have not had that opportunity to do for to date.” – Terry Duffy, CME Group CEO.
CME Group legitimizing Bitcoin could be just a bid of institutions trying to capitalize on extreme volatility and investor naiveté. However, it is possible that institutional regulation of cryptocurrency assets, complete with generated audit trails, could bring a level of stability to the cryptocurrency market. CME Group has not denied that Bitcoin and cryptocurrency is caught in a speculative bubble, but have instead argued that their job is not in establishing a fair market price level, but is in helping mitigate risk for assets that are in demand. Institutional investors have also been flirting with the idea of introducing cryptocurrency based ETFs (exchange-traded funds) that will allow investors to invest in cryptocurrency at a risk adjusted rate.
Regardless of what position one holds on the cryptocurrency debate, institutional involvement in the decentralized cryptocurrency market should be viewed as a positive breakthrough for both sides; allowing skeptics to go short safely, and endorsers to diversify their existing market portfolios.