Bitcoin: Why you should buy all time highs, just as Jesse Livermore would advise.
Please read the disclaimer here: https://en.theadaptive-investor.com/disclaimer
(When reading this article, don't forget the following: flexibility and admitting your mistakes is the key to success, being able to predict the future is not. From this we can deduct that risk management is crucial when investing. Please do not forget this.)
A few weeks ago, I made a video (see here) with a recapitulation of my 2021 market views. To cut a long story short, I saw that the risk-on environment was starting to come back. I updated this view with some charts on twitter two weeks ago (see here).
In this article, we'll have a look at the price action of risk assets over the last few weeks.
Let's start with copper. When copper reached its 2011 all time high again in May 2021, I warned that we would probably see a lengthy correction/consolidation (see here). This is indeed what happened. Three weeks ago however, copper managed to break back above its 2011 all time high. This seemed to be another indication that risk on was back. Since then, copper broke back down below this level and we now need to wait and see how the price action will develop. Either copper needs more time to consolidate overhead supply, whereafter it can start to rise again. Or copper will not materially break above the 2011 highs but will correct further in 2022 when we get into a risk-off environment. (Yes, in Q2 2022, things could get very interesting, more on that in future articles.)
The theme that the risk-on environment is back was supported over the last few weeks by the price action in small and mid cap stocks.
In April, I started to warn about the possibility of a risk-off environment developing. We saw it in several asset markets but the broad risk-off price action didn't spill over to the broader equity market. (I explained my reasoning in this video from a few weeks ago.) This doesn't mean however that the call was completely wrong. Have a look at the following chart. Small and mid cap stocks went nowhere for multiple months. It's only in the last two weeks that they started to break out from a 5-7 month consolidations. Needless to say, this is confirming that risk-on is back.
(Other elements that support the idea that we saw a risk-off environment in a lot of asset classes this year:
-copper corrected 15%, I warned about copper here
-bitcoin had a correction of 50%, I warned about bitcoin here
-half of the stocks in the Nasdaq had a correction of more than 20%.)
My view that this risk-off environment would spill over to the broader equity market didn't come true and I started to become bullish again when I saw the price action in Bitcoin. I warned about the badly looking price action in Bitcoin in April, right before it had a correction of 50%. However, once Bitcoin was able to break back above the +-41 000 level, I started to become bullish again.
Three weeks ago, when it reached its all time high again, I wrote that I would like to see a consolidation, before we could move higher again. This is exactly what we have been seeing over the last three weeks.
If I look at the weekly chart of Bitcoin, I can't get rid of the impression that this is looking extremely bullish. We have been consolidating for three weeks right above former all time highs. The weak hands have been selling to the strong hands, and soon overhead supply will be gone whereafter the price can continue its rise.
Some people are afraid of buying something at an all-time high. They think they are late to the party and that the possibility of a big correction is now way higher. If only they could have bought the asset earlier on...
I'm not certain that this is a good way of thinking. Sure, when copper reached its 2011 all time high again earlier this year, I warned that it would probably see a consolidation/correction. But becoming bearish/bullish on an asset when it reaches an all time high is completely dependent on the price action that precedes it. Copper prices more than doubled from the March 2020 low without significant corrections. Sure, a healthy consolidation/correction was needed. Technical indicators like the RSI were also extremely overbought.
But the all time highs in Bitcoin are completely different. Bitcoin just had a correction of 50% and the price was able to get back to its all time high. How big are the chances that it just did this 'for fun'. Bitcoin had the perfect opportunity to fail in July this year but it didn't, it came back and has now been consolidating for three weeks at all time highs.
If you are afraid of buying all time highs, have a look at the following chart. The chart shows the price of bitcoin and each red dot indicates when Bitcoin reached an all time high. At the end of 2020, Bitcoin reached it previous all time high (set at the end of 2017) and a red dot is drawn. What followed? A collapse in the price? No, more red dots followed the first one. Once an all time high is breached, we often see a parabolic run in prices. This is not something specific to Bitcoin, we see it in all asset markets. Buying an all time high might be difficult emotionally, but rationally you should think of doing exactly that.
source: @Erik_Hansen_
I'm not the first person who has discovered this. Jesse Livermore knew this 100 years ago as well...
Jesse Livermore: "The fact that a stock is selling in new high territory should only encourage a speculator."
Another way to look at this is through the following chart.
The blue area shows the distribution of annualized returns when Bitcoin is trading off an all time high (defined by Bitcoin being more than 5% from its all time high.)
The red area shows the distribution of annualized returns when Bitcoin is near an all time high (defined by Bitcoin being less than 5% from an all time high.)
As you can see, the return distribution is much, much, much better when you buy Bitcoin near an all time high.
You can read Nick Maggiulli's full article (source below chart) and see that the same return distributions hold for different asset classes (including gold). Buying an all time high might not be so a bad thing after all.
source: Should you buy an all-time high?, Nick Maggiulli, ofdollarsanddata.com
As an investor (I personally don't trade or speculate in any asset class.), you want to buy strength. From a mathematical viewpoint, this gives you the highest probability of success.
Gold is the perfect example. A lot of people have been trying to call the bottom for the last 18 months. Me personally, I also indicated on a few occasions that a good risk-reward opportunity was setting up. But, how bullish these set-ups might have looked, they all failed. That's why I stopped trying to catch the bottom. When will I invest in gold again? Two possible scenarios are possible:
-I'm not able to catch the bottom (or anything close) in gold. (This can be because my analysis was not good enough or because I was invested in other things with a better risk-reward.): No problem, I'll just buy the new all time high when the rising trend in gold has clearly reinstated itself.
-I'm able to catch the bottom (or anything close) in gold: My current guess is that somewhere in 2022, we'll see a big change in the market character. If I look at several leading indicators with regards to liquidity, earnings, the economy,... they all are showing that a big shift is underway. In my opinion, that will be the moment to invest in gold again.
Thank you very much for reading my article. You can follow me on twitter: @adaptiveinvest