Bitcoin: poised for a large rally?

Bitcoin presently offers a positive risk-to-reward long trade.

[Originally published in today's TrendCompass report - 7 Nov. 2022] Technical Analysis, regarded as superstition by many – perhaps most – investment professionals, can be extremely useful to traders, not as means of prediction, but as means to identify trades with positive risk-to-reward attributes. In the past, I identified valid trading signals for Bitcoin, based entirely on TA:

• 14 May 2021: “Bitcoin reversal? Three technical warning signs!” – while bitcoin was still trading above $50k TA patterns indicated the risk of a sharp correction. Over the next 6 weeks, bitcoin dropped below $30k.

• 14 July 2021: “Bitcoin: a buy at $32,000?” – in the aftermath of that correction, TA suggested a possible bullish reversal and a good risk-to-reward trade. I suggested it could rally to $50k, which it did by early September 2021.

I think it should be clear that there was hardly any valid fundamentals-based approach to suggest these trades. Only with TA it was possible to identify a few valid navigation guide posts. Today bitcoin offers another good tactical trade, as the following chart shows:

The analysis

October price action broke the 12-month trend line as Bitcoin feebly bounced off of the support area above $19k. During this time Bitcoin dipped below $19k a few times during September and October, setting an intra-day low at $18,005 on 13 October. The next trade would be based on three elements:

1. Confirmation of the support area ($19k),

2. Breaking of the trend-line, and

3. Trending higher since mid-September.

From here, bitcoin may be poised for a more significant rally over the coming weeks. 

It’s not about making predictions

The trade is not be about getting the prediction right. Rather, it’s about considering and planning a tactical long trade from the present levels. A rally, if it takes off, could easily reach the next resistance level at about $30k or even beyond, to $40k – $50k. On the down-side, we can guess that the present support level will hold, at least temporarily, and set our stops just below $18k.

As I write these lines (Monday, 7 Nov. 2022 at 14:40 GMT), Bitcoin is trading at $20,746. Thus, the proposed trade would have roughly $10k to $30k up-side and less than $3k to the down-side. 

With regards to the above chart, another few observations are in order: again we see that markets move in trends. Nobody could have predicted last year’s top for bitcoin, or the duration and magnitude of the subsequent correction. But that correction did play out as a trend, spanning a full year. With effective, high-conviction trend following strategies you did not need to predict any of this. What you needed was patience, discipline and judicious risk-management (i.e. not getting in over your head). 

Now, I always advocate using systematic trading strategies, but if you consider making discretionary trades, you must be prepared to stick with the plan: if you set your stop-loss at $17,995 and the price of bitcoin drops below that level, be sure to take that loss and exit the trade. A drop below the stop-loss level would reconfirm the downtrend, and possibly many more months of decline.

It is always better to keep your powder dry for another shot when an opportunity presents itself. Unfortunately, most traders are inclined to “average down” as the purchase price of a security declines. This is why 4 out of 5 active traders lose money – it’s an empirical fact. For example, check the brokerage advertisement below: it says that 83.45% of retail investors lose money!

Keep it simple!

Technical analysis should be simple. Many analysts unduly complicate things, I don’t know why – maybe it is to impress their clients or their employers. But this could be a sad waste of talent:

I’ve studied and used TA for over 25 years now, and this is not the way to do it. In fact, I suspect that the above charts are the reason why TA seem like superstition to so many people. What TA should yield are identifiable, high conviction trades where you can take directional exposure, hopefully time your trade a bit better than random, and plan your loss if you’re wrong. Whatever prediction is implicit in your analysis (today's example being that Bitcoin might rally), you should always assume that there’s a 50% chance that the prediction is wrong.

What we’re after is a positive risk-to-reward proposition and some clear guide posts around which to manage your risk. That’s all.

Alex Krainer – @NakedHedgie is the creator of I-System Trend Following and publisher of daily TrendCompass reports, covering over 200 key financial and commodity markets for investors and traders – probably the best CTA daily newsletter on the market today. One month’s test drive is always free of charge – no strings attached!