- Volatile nature of Bitcoin, which is driven by narrative, lends itself well to momentum trading
- Trying to call highs and lows for Bitcoin is far more challenging than trying to trade with the trend using momentum trading
Buy when Bitcoin keeps going up, and sell when it keeps going down.
As ludicrously simple as that may sound, that’s the simple recipe which has powered profits for Bitcoin day traders as increased retail and institutional interest in cryptocurrencies has generated substantial volatility for the world’s favorite cryptocurrency.
Although many analysts criticize Bitcoin’s volatility as making it unsuitable for a portfolio allocation, others are using that volatility for profit, and lots of it.
So-called “momentum trading,” the premise of these Bitcoin day traders is rooted in decades of behavioral analysis, backtesting and academic rigor. Trying to time Bitcoin’s top or bottom is like trying to read tea leaves or tarot cards – you’ll find whatever it is you’re looking for. But “momentum” buying of Bitcoin just looks to keep buying until there is a reversal and then start selling until that trend reverses as well.
Although this trading strategy is subject to crashes, as when Bitcoin corrected sharply when it neared US$42,000, it’s perhaps no more risky than a simple buy-and-hold strategy, given the inherent volatility of Bitcoin anyway.
As fiscal stimulus feeds a new retail-trading mania in cryptocurrencies, risk assets, especially cryptocurrencies, have continued to gain. Ether, the world’s second largest cryptocurrency by market cap, is up some 90% in the first three weeks of this year, while Bitcoin is up just under 30%. But quantitative and systematic traders, who rely on powerful algorithms and automated bots, have an edge over retail investors, when it comes to momentum trading strategies, especially for Bitcoin, where the bulk of trading remains automated.
That doesn’t mean that retail investors are completely feckless though when it comes to momentum trading. Bitcoin’s price right now is feeding into an “inflation narrative” that suggests more profligate fiscal policy as well as loose monetary policy, have the potential to debase fiat currencies, bolstering Bitcoin’s deflationary appeal as a store of value.
And a structural empirical model developed by Bloomberg Economics highlights that as much as 60% of the latest Bitcoin rally cycle, starting from October 2020, can be attributed to momentum trading. Day traders are also increasingly influential when it comes to Bitcoin’s wild price gyrations, with the number of dedicated-Bitcoin Twitter (+3.64%) feeds, Reddit threads and TikTok videos exploding since the last quarter of 2020.
As an unconstrained asset, Bitcoin is particularly susceptible to narrative and by extension, momentum trading, Bitcoin day traders will however still need a relatively strong constitution and discipline to swim with the Bitcoin price currents.
