Lesson #13: The Art of the Bubble Series

All bubbles crash. But they don’t collapse in 2 or 3 days. And they don’t go straight down. That means you can make money on the bounces during the crash itself.

It’s easiest to explain if we start with an image of the 2017-18 Bitcoin crash.

This chart has a lot going on since it uses the indicators I explained in Lesson #12 about scaling out of your trades. At the bottom of the screen is the fastest indicator, the 21-day Price Rate of Change. It gives false sell signals but is also the first to tell you when to trade out. The idea is to trade out part of your position when that goes negative.

The next fastest indicator is the 50-day simple moving average; it’s the red line. The idea is to sell another part when the price drops below that line. The black line is the slowest 160 simple moving average. The strategy again suggests selling out when the price drops below that.

Selling out in parts like this can reduce your losses quite a bit while also keeping false sell signals to a minimum. Lesson #12 explains this all in more detail, with even more signals for better trades.

The Bitcoin bounce happens only after the price has crashed below all of those indicators. What you see in the image is a sizeable move up, from $6,955 to $11,403. That’s a 63.9% bounce!

The point of this lesson is to explain a strategy for catching that bounce and maximizing your returns on it. Using historical data, you can expect about 2.5x on that bounce using something other than Bitcoin itself. Doing this might give you a final 160% return during the middle of the crash.

You could count this as lesson number 3 specifically devoted to The Art of The Crash.

• The first lesson, titled “The Art of The Crash” explains why shorting a bubble isn’t a very good idea and instead explains a re-accumulation strategy.
• The second lesson is, obviously, the lesson about scaling out of your trades.
• This lesson is devoted to the bubble bounce.

Notably, paid subscribers receive updates from my algorithms on a weekly or daily basis. They also get updates on exactly what I’m holding and when I’m selling. 

Bubble trading is an art after all, so a good deal of your education will consist in gaining the relevant experiences. Even if you don’t follow my exact trades, learning what I’m doing and why will help you gain the experience you need to make your own decisions. I keep the price for this education to less than a dollar a day because I want it to be reasonably affordable.

Yet even for my daily subscribers, this post will prove useful to understand what I’m thinking about. Especially on a day like today when Bitcoin is having one of its predictable pull-backs (it’s down 11% in the past 24 hours at the time of writing).

Let’s start with the relevant bounce indicator.

Rate of Price Change

If you didn’t like calculus in school, discussing rate of change might seem intimidating. But fortunately, you don’t need to do any math. You just need to be able to look at a chart and know what it means.

Getting to the chart is pretty easy. Just go to finance.yahoo.com and type in BTC-USD (since that’s Bitcoin’s price in terms of US dollars). You’ll get a screen that includes this. Click on the full-screen link.

You’ll then be looking at a chart like this. You need to change it so that you can see the daily price range.

Some people prefer candlesticks images, but I like the colored bars. Ticks to the left indicate the starting price of the day. Ticks to the right indicate closing price. The top of the line indicates the daily high, and the bottom the daily low.

You’ll next want to add the rate of price change indicator as follows.

Just go over to the indicators and type in something like “rate” and that’ll pull up the price rate of change. Click that, and then change the daily interval to 21. The reason we want a larger interval is that Bitcoin (or any bubbly item) moves really fast, so we need a slower indicator to smooth out the bumps.

Now scroll back to 2018 and let’s look at that crash. You’ll notice that the Price Rate of Change indicator hit a low point of -50. That’s extraordinary!

In fact, if you look historically. Since 2015, which is as far back as Yahoo has data, because they don’t think of Bitcoin as “mature” before that period, Bitcoin has only hit -40 or lower four separate times:

1. The low point of the 2014-2015 crash on January 13th.
2. February 2nd of the 2018 crash.
3. November 25 of 2018 at the end of that crash.
4. March 11 of the 2020 crash.

What does that mean?

Basically, it means that if you ever see Bitcoin hit a -40 on the Price Rate of Change indicator, you have a fantastically powerful signal that the price will bounce back.

A Leveraged Trade

When you see this signal, should you buy Bitcoin?

Not necessarily. If I were to advise my future self about this signal, this is what I would say: A bounce is not long-lived and bounces don’t always bounce back a lot. Those are two claims and it’s worth unpacking both.

Claim 1: A Bounce is Not Long-Lived

Historically, a bounce will see a peak prince within 15 days of registering its first -40 reading on the Price Rate of Change (pROC) indicator. Since cryptocurrencies trade 24 hours a day, 7 days a week, this is literally just over a two week period.

If you get in a little late, bare this point in mind. Also, if the price doesn’t bounce back as much as you’d like, also bear this in mind. Which point brings us to the second claim.

Claim 2: A Bounce is Not Always Big

The weakest bounce was at the end of the 2018 crash. The price bounced from $3779 to $4076 or about 8%.

You could try using the pROC indicator to make sense of when to sell, but the sample size is so small that I just can’t find any statistical significance in those signals.

It’s better just to keep that 15-day time frame and realize that some bounces are small. Instead of trying to hold on for a bigger run, then, it makes sense to use some leverage.

I wrote a whole deep dive about cryptocurrency miners for a reason: on an historical basis, they do about 2.5x whatever Bitcoin does.

• If Bitcoin bounces back just 8%, miners will tend to bounce back 20%.
• If Bitcoin bounces back 63.9%, then miners will tend to bounce back 160%.

You could also buy options on Bitcoin and a futures market exists for this even through the ordinary stock market.

The problem with options is that they are often illiquid and you have to pay extra to exercise them early. If you just buy mining companies, they are ordinary shares that will be easy to sell whenever you want with no additional fees for their sales.

Concluding Thoughts

A lot of bubble trading turns on planning for a bubble’s collapse. The very first lesson in this strategy is to remember that bubbles are irrational so that you can’t predict their top. Yet, since they make so much money at the end, it’s better to hold over the top and lose a little than it is to get out too early.

Many of the ongoing parts of the strategy concern how to know whether you should be selling. That’s why I wrote about the importance of the Basic Economic Cycle indicator (that paid subscribers get reports from).

Another set of principles concerns knowing whether you should be buying into a bubble if you are late, or as you continue to ride it up. Here are the actual trades, dates, prices, and weighted average cost for my Ether buys during this bull run. You’ll notice that I even held through the March 2020 crash = ??.

My largest buy was in early February of 2020, but since I realized that the bull run was continuing, it made sense to continue buying along the way. 

While I’m up more than 10x on my initial trades, my later buys brought down the performance metrics to a “mere” 881% return. But I’d rather have more money than perfect metrics.

I made decisions to buy in late using the techniques I’ve outlined here. It informed my even later buys of $UNI, $AAVE, and $YFI.

The final stages of bubble trading concern the inevitable crash. You need to know how to reduce your losses at the end of a bubble, you can use this lesson to play the bounce after the crash, and you can use a smart re-accumulation strategy to position yourself for the turn-around.

There’s a lot more to be written yet, but that’s the general outline of bubble trading from the beginning phases, through the middle phase, and into the ending phase.

That’s it for this week!

As a note, I’m beginning a YouTube series with a co-host to explain these principles in a different format and I’ll be shifting the payment system to Patreon. All subscribers who sign up before that change will be rewarded for their early support.

So, if you want to know where the money for this is going, it’s into these other formats. You should see the first videos in one or two weeks!

Notes & Disclosures

General financial disclaimer: I am not providing advice on financial investments and I am not a financial advisor. I am only explaining how I think about this process and imply no returns on your investments. As they say in the news industry, this is for entertainment purposes only. Please do your own due diligence before investing in anything.

Specific disclaimer: At the time of writing, I own a variety of cryptocurrencies, including Bitcoin and Ethereum. In general, I trade these, so by the time you read this, I may not still own them.