Posted by: John Vandivier | January 15, 2013

Trading the News and Bitcoin

In mid December I invested in Bitcoins. In the past month they have jumped from #13.3 to $14.2 each in value according to this reliable source. This is not just volatility in my view. It is part of a longer term trend. Why? That’s what this article is about.

In foreign exchange, which I have done personally for years, there are several techniques of how to predict changes in future price. They generally fall into one of two groups, either technical or “soft” trading, and those two groups are generally broken into two more groups for a total of 4 very commonly used, sweeping investment strategies. These strategies I am talking about in the context of FX trading but are used in all manner of financial securities trading including stocks and bonds as well. The 4 types are:

1 Fundamentals Trading (Technical)
2 Regression-Optimization Trading (Technical)
3 News Trading (Soft)
4 Psychological Trading (Soft)

Briefly, AND I MEAN VERY VERY BRIEFLY AND NOT AT ALL TECHNICALLY, this is how they work:

1 You see a change to the underlying structure and anticipate the result from theory.
2 You see the movements in the past and optimize a regression which best explains them, then extrapolate that pattern into the future.
3 You see a news story and try to assess how it will effect perceived value.
4 You observe price movements, volume, volatility, or other technical features, but interpret them through psychological trend analysis rather than their mathematical trend analysis (ie regression-optimization.)

I believe technical analysis is a bad idea for most people to engage in. The advent of investment robots means that any gains from technical analysis are already accounted for at faster-than-human ability. If you are trying to develop a new robot algorithm technical analysis MAY be useful, but even then some of the assumptions involved are sometimes shaky.

On the other hand, for better or worse, at least for the time being, these robots are unable to grasp the “soft” stuff. If a news story comes out that says that the Chief Accountant of ExxonMobile has been indited for Enron-like accounting techniques and will go to court to face charges, investors know that this has major implications for the real value of ExxonMobile stock and bonds, while robots have no clue about this.

If news comes out that the President or the Fed Chairman have been assassinated, investors know that this carries huge implications for the future health of an economy and therefore the value of that economy’s currency. Robots have no clue about this either.

A fundamental trader might not devalue a stock until the accountant had been found guilty or a new chairman had been named who instituted a new, poorer policy. The News trader and the Psychological trader would both know that even the potential will cause emotions, perceptions, and expectations by markets and traders, and therefore the possibility or discussion of the idea alone would be sufficient to adjust expected value of a security or structure.

Finally, a story can be neutral. Neutral stories, while they may not cause increased or decreased perceptions, will increase attention. Increased attention often results in increased volume of trading. The effect of increased attention and volume of trading is simply to accelerate whatever trajectory the value of the structure or security was already on. If it was “moving sideways” as we say (neither increasing nor decreasing in value), it will continue to do so. However if it was increasing modestly, it will accelerate in its increase, at least toward whatever target value it was approaching.

How does this all relate to Bitcoin? First of all Bitcoin has been in the news more and more recently. From the soft view this indicates that we will have increased attention and therefore Bitcoin’s trading value movement will accelerate in whatever direction it has already been moving. Furthermore the majority of news on Bitcoin has been very positive, which should indicate a positive bias on the trend. That trend, even before the attention, was already positive.

The news needs to be analyzed from a financial, investment, or economic paradigm, however. As the link above showed for a simple search of bitcoin news stories on google news, two stories were about bitcoin being used for money laundering and gambling. Further research on your part will inform you that bitcoin can even be used for purposes of buying and selling drugs, weapons, and prostitution!

The point is this: There are things which may be morally undesirable but have positive implications for financial valuation. A News Trader would read these stories and think, “Oh look! Larger market share and increasing demand!” He would not say, “Money laundering is bad and bitcoin is being used by money launderers therefore bitcoin value or price will or should go down.”

In addition to the soft arguments which I find most important in the short-term, Bitcoin is also fundamentally sound and undervalued in theory which is good for the long term. I will discuss one fundamental point of interesting analysis in a future article, but you might start with this:

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Responses

  1. You might want to check this technical analysis program: http://www.cognitum-research.com/en/wave-explorer


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