Learning From The Bitcoin Bubble

Having emotional control is one of the keys to trading success. The bitcoin bubble was a time I witnessed many people losing theirs to irrational herd-like behaviour.

It was fascinating to see. This article talks of that particular boom-bust, and what it can teach us as traders - no matter what the timeframe we're using.

The next time you think of hopping on board a bull move that's in the throws of mass euphoria, think twice before pulling the trigger.

 

My local bar – hangout of drunks, low life’s and Bitcoin millionaires

There’s a bar in a small lane where I live in Chiang Mai, northern Thailand.

Its customers are the day-time booze crowd looking for cheap beer and liquor. It’s in no way a ‘girlie bar’, as is so often imagined of the country.

Nope, this bar is a dive bar - pleasant enough, but where punters (usually western guys) go to get slaughtered before (if they can still stand) moving on to other haunts.

It was here, where the bitcoin bubble first grabbed my attention.

The guy next to me was mumbling on about how much he was making in the crypto market..

It wasn’t just him though.

I’d heard the name, bitcoin, mentioned multiple times that week.

And if I recall correctly, he wasn't the only 'bitcoin trader' in the bar that day.

 

Student of bubbles

I love history and I love markets. So, it’s been a no brainer for me to study market history.

Our past few hundred years have witnessed several market bubbles.

From John Law and the Mississippi scheme, the South Sea bubble and Tulipomania. To Japan in the 1980s. The dot.com bubble of the '90s. The housing bubble of 2007.

I even participated in more than one – what I call, mini bubbles – in the precious metal markets. I knew mass hysteria when I saw it.

The cycle goes something like this:

 

Smart money starts buying up on the cheap.

Early innovators or true believers start entering the market. There isn't much exciting going on with price at this time. This could be called the 'accumulation phase'.

Institutions get involved

Large buy side firms can only get in with lots of liquidity. In the stock market, many can't even buy stocks under a certain price.

Their footprints would be all over the market, pushing up prices.

So only when prices have risen do they enter. They're accompanied by savvy traders who wait for a breakout of the base pattern

Meanwhile sell-side analysts are touting the idea to their high net-worth clients.

Momentum gathers and a trend develops.

Stealth bull market

Momo traders jump on board now.

Savvy retail investors join the party, after reading mainstream newsletters. Networks like CNBC and Bloomberg start talking about it.

Mania phase

There's a feeling the technology (or whatever) can change the world, or make everybody rich. If you go to a cocktail party that's the main topic of discussion.

The new tallest shiny skyscrapers are going up around the world.

Blow off phase

The market’s hitting front pages of newspapers daily and mainstream news channels.

Shoe-shine boys would been touting stocks in Joe Kennedy's day. Nowadays, its' taxi drivers and lift attendants getting in on the act.

This time really is different.

The market is stretched well above its 200 day moving average. The early entrants are selling.

This is accompanied by increasing mass delusion in the media - the perfect cover for large investors to dump their holdings.

When the last fool buys in, the market starts to swoon.

Those late to the party don't know what's hit them.

 

Rinse dry repeat

This is all very predictable and has been documented countless times - from Charles Mackay’s Popular Delusions and the Madness of Crowds to the movie, The Big Short.

While these cycles are generally measured in years, even decades, we can see similar patterns repeating on a short-term basis.

Sideways accumulations, breakouts, stealth bull moves and finally parabolas. The aim is to get when there is little activity or interest.

Strategies such as the Harami Inside Bar are one such way of doing this on a short-term basis.

 

Back to bitcoin

I asked my new drinking buddy about how bitcoin worked.

I found out it was traded via a digital wallet.

And took five days too clear.

And the final settlement price of your 'trade' might not be the price you originally sold at (this is not strictly true, there are some very professional trading exchanges out there).

But whatever this thing was I wasn't going to be buying it in a hurry.

I was though, genuinely interested why people were getting so damn excited about it.

 

Investment tips from a drunk

Me: 'What's so special about bitcoin?'

Drunkard: ‘Well, the math means it's going to $100,000’

Me: ‘The math? What does that mean?’

Drunkard: ‘The blockchain.'

Me: ‘The blockchain? What's that?'

Drunkard: 'Blockchain is the future. Also, it's outside the financial system, it can't be printed out of thin air. Plus the people own it.'

Me: 'Hmm.'

My personnel favourite answer was when he told me how safe cryptos were.

I came to realise this is so not true; what with high profile thievery at crypto exchange Mount Gox not too mention the risk of losing your private key code, safe it was not.

Drunkard: ‘I’ve made 1000% so far. Have you ever made that?’

'Yep, many times.'

Drunkard: ‘Don’t you trade the markets for a living? You should really get into bitcoin.’

Me: ‘Nah, I specialise in stock indices. Besides, I never trade a market I don’t understand.’

Drunkard: ‘Indices are shit; you don’t know much about trading do you?’

I asked him what his exit strategy was? How would he know if he was wrong?

Drunkard: ‘Oh no, this is a long-term investment. I’m not selling.'

I then looked up the bitcoin chart on my phone. As I suspected it was stretched something ridiculous above its 200 day moving average.

Me: ‘Mate, this is a bubble and it’s going to end badly.’

Drunkard: ‘You don’t follow those charts and candles do you? That’s gambling.’

All I could do was drink more beer.

 

The new investment mantra -Hodl

Hold on for dear life has to be the stupidest mantra I’ve ever heard. I mean seriously, who came up with that crap?

Hearing this just confirmed everything I was seeing - it was a bubble and it was about to pop. Big time.

These guys were clueless. My Persian cat has more financial acumen.

Check out the video below to see just how bizarre things were getting.

 

Bitcoin smashes 10K

I told my new drinking buddy, BTC would hit 10K, and then drop fast.

It was a guess, one fuelled from one beer too many.

But I just couldn’t resist pissing on his parade.

My drunken logic was there would be strong resistance at 10k. I should have just kept my mouth shut.

Over the next few days, I watched closely hoping my prediction would come true.

It hurdled 10k in a minute and didn't look back.

It closed above that level on the 28th November 2017.

Then it backed off for two days.

On the 30th November, it closed at $10,233.

The 1st December, $10,975.

2nd December, $11,074.

3rd December, $11,323.

I just knew the conversations in the bar were going to be painful that week.

On the 7th December, it vaulted to $17,899.

And on the 16th December, it closed at $19,487.

 

My bubble thesis in tatters

‘I told ya’, was the predictable response I got at the bar that Xmas.

Here I was a trader of 15 years, getting mediocre returns when clueless idiots were raking it in hand over fist.

There’s nothing worse than seeing those less informed, getting richer than you. That’s double, no, triple true when you're supposed to be the expert.

I’d heard of friends of friends, now millionaires, buying big houses and quitting day jobs all on the back of bitcoin.

I was gutted.

I'm not a hater by any stretch.

I'm usually the first to congratulate someone on their success. But this was different. My whole theory on markets was up in smoke.

Cryptos really were different.

It was the first market to ever be traded solely online.

And maybe all that mass participation meant it could go both higher and quicker than any other time in history (it had already surpassed Tulipomania in terms of performance).

Maybe the math did work after all– still not understanding what that was supposed to mean.

 

Bitcoin comes crashing down

One thing I knew was the CME had introduced a bitcoin futures contract.

This should be interesting, I thought.

I'd been around when the first gold ETF hit the market. All the talk prior to that day was how gold was going to da moon because of it.

The opposite happened. When the ETF came out, gold started falling.

Was this time going to be like then?

Surely all those canny futures traders would see how euphoric this market was becoming?

I soon got my answer.

Bitcoin never did get past $19,487.

By February, it was back below $10k. It then traded sideways for the next month or more.

Come April, it closed below $7,000.

And by November, below $4,000. Ouch!

Many people had bought at the top. I knew a few of them myself.

 

Bearish news

Who knows if futures traders had somehow shorted the pants off bitcoin, and it started a sell-off in the underlying market?

What I do know is there was a consistent barrage of negative press.

Central bankers took their turn to beat the crap out of it.

There was no way they were going to let it usurp traditional fiat money. That was always my main bearish argument.

Also putting the boot in was JP Morgan's, Jamie Dimon and many others in the finance industry.

There was alongside an endless onslaught of hacking news, unfavourable regulatory rulings, and general pessimism on anything crypto. If you were a conspiracy theorist you thought it was an organised takedown.

Bitcoin investors were made to look foolish.

I dare say, without the negative press, BTC might not have fallen nearly so much.

I've never seen a market so collectively hammered by the press, (not even gold), as bitcoin was then.

 

My bitcoin conversion

I never ever had an issue with crypto, I'm pretty agnostic about markets generally. They go up, they go down.

But the move had turned into a mania, and a major sentiment rebalancing was needed - badly.

What I witnessed will forever be a part of financial history. I was glad I'd been around.

I continue watching bitcoin. And since then, have become familiar with the crypto scene.

And here's the kicker - bitcoin has now become my favourite market to trade!

From a short-term traders perspective its a thing of amazing beauty.

Tight consolidations followed by large range expansions -the bread and butter of my profits.

If you're looking for serious R multiple I doubt you'll find a better market than this.

But I'd never trade it with a wallet or exchange. All trade bitcoin CFDs, a total godsend for traders.

I do though look forward to the day when a new bitcoin bubble emerges, making it much further than the previous one which ended at $19,425.

 

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John Scott
John Scott has been trading CFDs and FX since 2003. His favourite markets are the Dow 30, Gold and the GBP/USD. John believes short-term price action trading is the best approach for beginners to trade. Tradeneophytes is his humble attempt at helping new traders reduce the learning curve to trading success.
Posted in Trading Psychology.

John Scott has been trading CFDs and FX since 2003. His favourite markets are the Dow 30, Gold and the GBP/USD. John believes short-term price action trading is the best approach for beginners to trade. Tradeneophytes is his humble attempt at helping new traders reduce the learning curve to trading success.

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