Bitcoin Might Be About To Come Back To Life

Bitcoin Might Be About To Come Back To Life
Jonathan Hobbs, CFA

almost 2 years ago4 mins

  • Bitcoin’s weekly volatility – as measured by the width of the weekly Bollinger Bands – is at historically low levels right now.

  • Volatility is mean-reverting. For bitcoin, that means a period of very low volatility is usually followed by a period of very high volatility.

  • Bollinger Bands don’t tell us which way the price will move when volatility eventually expands. So plan for either scenario.

Bitcoin’s weekly volatility – as measured by the width of the weekly Bollinger Bands – is at historically low levels right now.

Volatility is mean-reverting. For bitcoin, that means a period of very low volatility is usually followed by a period of very high volatility.

Bollinger Bands don’t tell us which way the price will move when volatility eventually expands. So plan for either scenario.

Bitcoin’s price has been remarkably calm recently: a low-growth, high-inflation environment has left traders second-guessing themselves and bitcoin flopping around in a dull, messy range with no clear direction. In fact, bitcoin’s weekly Bollinger Bands – a measure of the crypto’s volatility – are showing their lowest reading for three and a half years. Now, though, there are finally signs that volatility could be set to come back with a vengeance.

What are the Bollinger Bands showing?

Bollinger Bands consist of three bands: an upper, lower, and middle band. The middle band is the 20-period moving average – the average price over the last 20 periods. The upper band is two standard deviations above the middle band, and the lower band is two standard deviations below it. Remember from my article last week on crypto risk that “standard deviation” is just a fancy term for volatility. In other words, Bollinger Bands show how volatile the price is relative to the 20-period moving average.

The chart below explains this concept for bitcoin using the 20-week moving average. You can see that the bands expand as the price gets more volatile, and shrink when the price gets less volatile.

Bitcoin price (blue) with weekly Bollinger Bands. Chart drawn with TradingView.
Bitcoin price (blue) with weekly Bollinger Bands. Chart drawn with TradingView.

Now that you’re up to speed with Bollinger Bands, check out the next chart I’ve made for you. It shows that, on the one hand, bitcoin’s weekly volatility is lower than it was in October 2020 – when bitcoin began its climb from $10,000 to $60,000. On the other, it’s nearly as low as it was in October 2018 – when bitcoin began its descent from $6,000 to $3,000.

Bitcoin price (blue) with weekly Bollinger Bands and Bollinger Band width indicator (green). Chart drawn with TradingView.
Bitcoin price (blue) with weekly Bollinger Bands and Bollinger Band width indicator (green). Chart drawn with TradingView.

In technical lingo, you could say bitcoin’s weekly bands are “pinching” right now. That’s a term traders use to signal a large potential move ahead – when the bands eventually break out of that pinch and widen from an ultra low volatility base.

Volatility is “mean reverting”, meaning it doesn’t stay at extremes for too long. And according to John Bollinger, who invented Bollinger Bands in the 1980s, low volatility (narrow bands) is usually followed by high volatility (wide bands). In other words, bitcoin could be gearing up for a colossal move in the coming weeks.

Problem is, pinching bands say nothing about the direction of the next move. According to the indicator, it could really go either way.

What’s the opportunity here?

If the move is to the upside, holding bitcoin would obviously work in your favor. You’d just want to “let your winner run” so long as the bands expand – and as long as the price trends near the upper band. In that scenario, the price would be increasing alongside volatility, making the uptrend stronger.

The chart below shows how that relationship worked out in bitcoin’s 2020-21 bull run, after a volatility squeeze of similar magnitude.

Bitcoin price with weekly Bollinger Bands (2020/2021 bull run). Chart drawn with TradingView.
Bitcoin price with weekly Bollinger Bands (2020/2021 bull run). Chart drawn with TradingView.

As with most assets, the “up like a staircase, down like an elevator” analogy usually holds true for bitcoin. So if the next move breaks bearish, I reckon it’ll be faster and more violent than the bullish alternative. Just look at what happened when the bands pinched this hard three and a half years ago:

Bitcoin price with weekly Bollinger Bands (2018 drop). Chart drawn with TradingView.
Bitcoin price with weekly Bollinger Bands (2018 drop). Chart drawn with TradingView.

A fast and furious downside move could present two opportunities. The first, high risk option is to short bitcoin using crypto futures on Binance, Bybit or FTX, or via CFDs (contract for difference) on eToro or Interactive Brokers.

But be very careful here. For one, you can’t legally trade crypto derivatives if you’re a US retail investor. And for two, you can have unlimited losses from short-selling – in percentage terms, the price can only go down 100%, but it can go up way more than that. So if you short-sell bitcoin and the price rips higher instead, you could find yourself in a world of financial pain. Setting a stop-loss to automatically get you out of a short position would help manage risk, as would using minimal leverage.

The second safer and more practical way to play a downside washout (if it happens) would be to simply buy the panic. Dollar-cost averaging or value averaging into bitcoin over a few weeks might offer a nice long-term pay-off here. After all, buying bitcoin at peak fear tends to reward the brave.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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