The rapid increase in bitcoin prices has made the cryptocurrency one of the most attractive investment opportunities in recent years. Those who had the foresight to buy bitcoin soon after its 2009 launch have made tremendous gains.
Less than eight years ago, bitcoin was trading at a mere US$0.06. Since then, valuations have increased rapidly and the price of the virtual currency now stands at about US$10,000. This represents a tremendous rate of return.
To put this kind of growth into perspective, consider the fact that US$1,000 invested in bitcoin in 2010 would be worth around US$199 million today.
Of course, prices have not risen consistently. There have been wild swings in valuations and many investors who have not held their bitcoin positions have lost considerable amounts of money.
Bitcoin’s price volatility caused it to fall from an intra-day high of US$20,089 in mid-December to an intra-day low of US$10,942 about a month later, high the fact that investing in, or trading on, bitcoin requires you to be comfortable bearing a high degree of risk.
Here are some strategies that you can use to tackle the cryptocurrency’s volatility:
Technical analysis can help identify trends
Many investors use technical analysis to forecast price movement in the future. What exactly is technical analysis and how does it work? Investors collect data about price movements and trading volumes. Then they analyse this data with the objective of establishing patterns which repeat themselves over time, in similar market conditions.
If a pattern is established, it is then extrapolated to forecast prices. Proponents of this form of trading know that bitcoin’s price movement is not random. They follow trends and patterns that could have both short and long-term implications. An investor who successfully discerns a trend or chart pattern can then use this information to help build their trading strategy.
Of course, this is not an infallible method for determining future bitcoin prices. But it does provide you with a basis to create your trading strategy. It is best to use it along with other tools that can help you to tackle the high level of volatility that bitcoin exhibits.
Identifying support and resistance levels
A support level is the value below which a security is unlikely to fall. This is because when prices reach this level, many traders step in and buy as they believe that any valuation below this level is low.
So, if bitcoin has tested and managed to stage a rebound at US$12,000 more than once, this observation suggests that there is demand for the cryptocurrency at the US$12,000 level. Thus, US$12,000 is now a “floor” for bitcoin which may stall any future decline.
Similarly, a resistance level is the price cryptocurrency could find it difficult to rise above it. A resistance is like a “ceiling” where profit-taking or selling pressure may occur to offset any demand.
However, support and resistance levels do not always hold. When a support level is breached, it suggests that selling pressure has overcome the previous demand and vice versa when a resistance is broken to the upside.
These occurrences are called “breakouts”. Therefore, traders need to be aware of market moving events when using support and resistance levels in their trading strategy and look to capitalise on such breakouts in order to profit from a change in sentiment. In addition, a support that has been broken to the downside will turn into a pull-back resistance and the reverse, when a resistance is breached to the upside, it will become a pull-back support.
Using moving averages
Instead of simply studying raw bitcoin prices, traders can also calculate moving averages to determine price trends. How does this help? A moving average serves to eliminate short-term volatility from the raw price data by “smoothing out noises”.
Here’s how it works. A five-day moving average can be calculated by summing the closing prices over the last five days and then dividing the total by five. Ten-day or 20-day moving averages can be calculated in a similar fashion.
Note that the moving average is calculated on the basis of closing prices for the day. This prevents the calculation from being influenced by intra-day volatility.
Establishing a price trend using moving averages can help you to make better trading decisions when you trade within the existing trend.
For example, if bitcoin is trading above a 20-day upward sloping moving average, it suggests that an uptrend is still in play.
On the flipside, a down trend is in play when bitcoin is trading below a 20-day downward sloping moving average.
Trade bitcoin using the MACD indicator
This strategy is more sophisticated than one that simply utilises moving averages. MACD is an abbreviation for moving average convergence divergence. It is an indicator that uses two moving averages.
A MACD indicator doesn’t use simple moving averages. Instead, it uses an exponential moving average. This is a moving average that gives greater weight to the latest data.
A common practice is to use a 12-day exponential moving average and a 26-day exponential moving average.
The MACD measures the convergence and divergence between the two exponential moving averages. It is calculated by determining the difference between the two. Finally, a signal line is plotted on the MACD to provide a trigger for buying and selling.
Using stop losses
Stop loss orders provide traders with a useful tool to help limit losses. A stop loss order can be used to close your position (in either direction) at a pre-determined price level set by you when you place an order. You can add a stop loss order to existing positions too, for added peace of mind.
Why are stop losses important? Using stop losses regularly means that you won’t need to constant monitor your positions if you are away from your trading desk or laptop. With the high level of bitcoin volatility, stop losses also mean that you can cap losses at a level you’re comfortable with.
Stop loss orders also help you to trade in a disciplined fashion.
It is important to remember the limitations of stop losses and that the price that you set is not always guaranteed. This is because markets can sometimes “gap,” rapidly dropping from one price to a much lower one as a result of extreme market volatility.
It is best to monitor your stops carefully. Don’t assume that they will always be automatically executed. While this may happen most of the time, there will be instances when your order does not go through.
Be prepared for a fluctuations
As an asset class, bitcoin is relatively new. Historical data on prices are available only for the last few years. Other asset classes like stocks and gold have price data that go back for decades or even longer. Additionally, bitcoin prices can be buffeted by new government regulations.
Regardless of whether bitcoin prices rise or fall, it is fairly certain that price actions will remain highly volatile. As an investor, it will be in your best interests to monitor prices carefully and exit a trade before your losses mount beyond a certain level.
Remember that bitcoin trading is only for those who are comfortable with a high degree of risk and price volatility.