Recently the Internal Revenue Service (IRS) ruled that bitcoin would be treated as property. It stated: “For Federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.”
While this ruling may create greater paperwork, there is a silver lining to the designation. It creates a new type of managed trading. Bitcoin as a currency would require Securities and Exchange Commission, Commodity Futures Trading Commission and National Futures Exchange regulation. However, as property, the IRS rules enable the emergence of management property funds that are aggregates of virtual property, which applies to bitcoin. Moreover, its price has experienced sharp moves, trading as high as $1,000 earlier this year and is now near $330, generating fears about its future (see “It moves”). While this price action may cause some to back away, it also generates trading opportunities. Let’s explore how should bitcoin be traded and the basic strategies and tactics in its development.
Like any other trading instrument bitcoin exhibits patterns such as parabolic curves, channels, and trendlines (see “Charting bitcoin”). These classic patterns provide boundaries for support and resistance. When these price patterns break, it indicates increased momentum. A price signal in bitcoin, like any other instrument, is generated by a change in the pattern, or failure to change. This point leads to our first tip on trading bitcoin.
Don’t get too complex, focus on pattern breaks: A simple, but valuable first approach for trading bitcoin is to look for pattern breaks. A factor here is the chart time frame. Intra day intervals are very choppy and result in less robust signals on breaks of the pattern.
At this stage in the evolution of bitcoin, traders face a dearth of data. Currency futures contracts would provide clues to the fair value of bitcoin but there are no traditional options to gauge sentiment. Sudden moves are more common as exchanges that offer bitcoin trading have not reached a stable degree of liquidity. Large orders will affect price. Bitcoin swings are still much greater than those of the EUR/USD or gold. Because it is a fairly new underlying market, there is not enough data to generate reliable forecasts. Any rumors are likely to move the price. As a result, traditional approaches using indicators that smooth out historical data frequently will fail.
Trade longer time intervals to avoid intra-day noise: Bitcoin is still relatively illiquid and subject to short-term spikes, so traders should take a longer-term approach.
While bitcoin is not easy to trade, its most important value may be as a non-correlated asset. Portfolio theory supports the notion that the total return of portfolios increases and risk of drawdowns is reduced by adding a non-correlated asset to an account’s portfolio. The problem in trading currencies is that all currency pairs have a high degree (near 80%) of correlations to each other. Here is where bitcoin’s contribution to trading may be its greatest virtue. It appears to be the least correlated asset class, especially if you bucket it in the currency space. From Jan. 4, 2014 to Nov. 4, 2014, bitcoin was 58% correlated to EUR/USD. Bitcoin’s volatility price range was between –5% to 10%, as opposed to the EUR/USD during this period, which was –1 to +1% range. Hedge funds should take notice by adding bitcoin to their set of asset classes.
Forex traders can trade bitcoin to reduce risk: The trading landscape for bitcoin also is seeing the emergence of binary option trading. Significantly, IG Market offers—for non-U.S. residents—daily, weekly and monthly fixed payout binaries on bitcoin. This provides an easy and limited risk way of trading bitcoin without needing to trade only on platforms and exchanges. It may be a harbinger of innovative methods to come. In any case, don’t count bitcoin out. Virtual currencies are now part of the global set of trading instruments. They won’t go away and forex traders may have new opportunities for trading.
Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He can be reached at firstname.lastname@example.org.