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There are many who think the rapid rise in the price of bitcoin is a bubble ready to burst. But how should a trader position himself if a fall in bitcoin prices does occur?
Bitcoin prices are now in a bubble that’s set to burst, say the detractors. The run up in prices in 2017 has been faster and quicker than in other known bubbles, such as the tech stock bubble of 1999. The price run is even being compared with the tulip mania seen in Europe in the 1600’s. This period saw a parabolic movement in the futures price of a single tulip bulb to ten times the annual income of a skilled worker. Inevitably, the speculative bubble popped and the price crashed. Fortunes were lost in a matter of days, and many believe this is likely to happen to bitcoin and other cryptocurrencies.
There have been a number of events in bitcoin’s past that have caused significant downside pressure. Here are some of the causes:
Whilst these risks are inherently part of a decentralised cryptocurrency, it’s interesting to see that while many people are calling the top for bitcoin prices, not many have followed up with a trade. There are many potential reasons for this, but a prominent answer you hear is that it’s hard to short bitcoin.
In more traditional markets, shorting is possible by borrowing a share or contract from someone else, selling it at the current market price, and then buying back the original asset when the price has (hopefully) moved lower. You can then give back what you originally borrowed, and pocket the difference in the price.
This can be hard for bitcoin because there are significant risks in lending out your cryptocurrency to someone else without an intermediary. If you were to lend bitcoin directly to someone else, there would be nothing to stop them from pocketing the digital currency and disappearing forever. There are, however, other options if you are looking to short bitcoin.
One option would be to spread bet or place a CFD trade on the price action of the cryptocurrency. This can be accomplished without holding or borrowing the underlying coin.
When you trade cryptocurrencies with a spread betting or CFD provider, you are placing a speculative bet on the point movement in the underlying market. This not only means that you don’t need to borrow or hold the underlying cryptocurrency, but it also means that you don’t need a crypto wallet or have to deal with the movement of bitcoin between exchanges, wallets and other people.
When you spread bet on bitcoin you place a size-per-point you are looking to trade against each dollar movement in the underlying asset. For example, if you were to place a spread bet of £5 per point, you would make or lose £5 for each dollar movement. If you were shorting bitcoin and the price went from $4000 to $3990 you would make ten points, and therefore £50. By the same principle, if the market moved against you and went from $4000 to $4015 you would lose 15 points and therefore be down £75. CFD trading is the same, however each value per point is based on a contract size rather than bet size.
Shorting any asset can be risky, but due to the volatility of bitcoin and other cryptocurrencies, it’s very important to pay particular attention to risk management. Whenever you are planning your trade it’s worth having a look back at historic price action to see what sort of movement you would expect to see in a normal day, and to use stops to manage your risk.
Bitcoin and other cryptocurrencies have seen significant price movements over the last few years. As with all assets, no one knows for sure where the price will be tomorrow, let alone in a year’s time, and this provides both trading opportunity and risk in equal measure.
Prominent critics of bitcoin, such as JP Morgan Chief Executive Jamie Dimon, have said that the cryptocurrency could go to $10,000 or more before the bubble bursts. Others point to the fact that people have been calling the end of bitcoin since 2010 when a single coin was priced at $0.23.
With this in mind, a good trade plan and an understanding of risk management principles is essential.
Sign up for our free three-part guide, you'll find out:
The brief but exciting history of cryptocurrencies
The factors that drive cryptocurrency prices
The differences between trading physically and on leverage
How to get started with IG
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