Another Day, Another Correction in Bitcoin

Stock investors consider a 10% decline to be a correction. Bitcoin investors must now consider a similar move to be just another day at the home office. As I write this, the largest cryptocurrency is down just over 10% with no apparent catalyst for the move. By the standards of any normal investment, this is eye-watering volatility. But bitcoin is no ordinary investment.

Long ago I wrote about the staggering momentum in both bitcoin and Tesla (TSLA). Actually, it was just under two weeks ago – Friday, January 8^th. It just seems like long ago in crypto-trading time. In that piece, I warned that “Parabolic moves usually come to a nasty, unpredictable end. But timing that result is nearly impossible, and the catalyst is often something trivial.”By the following Monday, bitcoin had fallen nearly 30% with no apparent catalyst. Traders used that volatility to buy that dip, causing bitcoin to nearly recoup all its gains by the end of that week. But a new high was not to be found, and we have since seen a pattern of dips and lower highs (see graph below). That is not a positive technical sign.

One Month Graph of Bitcoin with 30 Day Candles

(Click on image to enlarge)

Source: Bloomberg

If we look at this chart agnostically, without thinking about the investment that is being graphed, we see that pattern of lower highs and descending moving averages. That is a negative. On the plus side, we have not broken the 29,000-30,500 support levels. Those would be a key test of the recent rally. A failure could have some nasty implications, as seen in the graph below.

One Year Daily Graph of Bitcoin with Fibonacci Retracement and Moving Averages

(Click on image to enlarge)

Source: Bloomberg

This is a phenomenal performance, and those who bought bitcoin anytime in the first three quarters of 2020 and held it into 2021 were richly rewarded. We can also see the parabolic move that the cryptocurrency underwent during the fourth quarter. That type of advance leaves us very extended. The 61.8% retracement and 50-day moving average roughly converge around 27,500. That would be a logical next stop if the short-term support is breached, and that would be another 10% down from here. During most of the prior year, bitcoin used the 100 and 200-day moving averages as support. A retreat to the 100-day average would be a nearly 50% retracement from the recent highs. 

Any bitcoin investor must now ask himself if he can withstand a 30-50% drawdown. We have already seen moves of similar magnitude over short periods of time, so that is hardly an unreasonable question. The historical volatility of bitcoin is quite high, with the 20-day measure weighing in at over 100%. If that sounds abnormally high, it is not even close to the highest levels that we saw within the past year:

Bitcoin Historical Volatility Measurements Over the Past Year

(Click on image to enlarge)

Source: Bloomberg

Using the Rule of 16, we understand that a 100% annualized volatility means that bitcoin has been prone to move about 6.25% per day. After a day like today, that is hardly unreasonable. (For comparison, the 20-day historical volatility in TSLA is about 56, or 3.5% daily.)Volatility is wonderful when your investment moves in your favor, but it is painful when it doesn’t. 

This type of volatility means that bitcoin is suitable for only the most risk-tolerant investors. I worry that many of the newfound converts have not fully appreciated that. That volatility also undermines the investment thesis that bitcoin can be a full-fledged currency or a store of wealth.No currency or store of wealth is prone to the type of movement that we see in bitcoin. Sharp-eyed readers can see that it moved over 1.7% in just under a half-hour – the time it took me to prepare the accompanying graphs. Bitcoin has been a great investment and trading vehicle for many, but it is suitable for only those who understand its risk, especially in light of the recent corrections.