Bitcoin — Bounce or Break?
What an interesting time it has been for Bitcoin and Cryptocurrency markets in general this week and this roller-coaster is not over yet.
As we come to the close of the 9th week of a localised downturn, most people are calling the current market a bear market, well, not me! No I am not a die-hard bull, just a pragmatic analyst who acts on what the data suggests and not what my emotions want me to do.
So, let’s get down to it shall we?
First off, I have established a simple linear regression channel which has been in place since early last year. The channel is two standard deviations wide from the median line and describes an upward trend.
In layman’s terms, the best way to think about a standard deviation is to say that the more variation/volatility there is in the price action of an asset, the more levels of standard deviations there will be within a linear regression model. In this case, having a range of two standard deviations is pretty standard whilst having price data that ranges within a span of one standard deviation is considered to be a very strong indication of high linearity and low volatility.
The next thing to know about the linear regression channel is the Pearson Coefficient value otherwise known as a P-Value. A P-Value of 0.5 or above means that the linear regression model being applied can be considered to be statistically meaningful. Again, for the everyday trader/investor, I would recommend just converting the decimal point to a percentage as the P-Value is an indication of the probability that the linear regression model is “accurate”.
Now, you’ll notice that I have put the word “accurate” inside quotation markers, this is because “accurate” is a subjective term in the world of statistics and modelling and no model can ever predict the future but it can reduce the risk in your decision making process by giving you an idea of the most likely course of action that will ensue.
Hopefully, by now, you would have noticed something really interesting on the linear regression channel that has been plotted on the chart. If you haven’t noticed it, go and look…….
Seen it? Yes, the P-Value for the current linear regression model is only 0.20 or 20% which makes this linear regression model likely to be invalidated at any point, however, despite the low Pearson Coefficient, you’ll notice that the price action for the previous 12 months has, by in large, respected the linear regression model boundaries relatively well. In a situation like this, I tend to anchor my decision process to the following presumption:
“If the P-Value is below 0.5 but the boundaries have been respected for 3 months or more, trade and invest as though the linear regression boundaries are inviolable until the linear regression model is invalidated.”
This is one of my clearly established personal trading and investment rules which helps limit emotionally biased trading.
From the perspective of the linear regression model on the previous 12 months of data, Bitcoin is clearly still in an uptrend overall. There will be some that claim I am mad but the fact is, from January last year (2021) to January this year (2022), the price of Bitcoin has increased and not contracted. I concede that the localised price action is in a retracement leg but as most of us know, a leg down is followed by a leg up and a leg up is followed by a leg down — This is not zen wisdom, just a basic fact that people are all too eager to ignore. This “leg down” is the current leg, the question here is, how far down does that leg go?
My view on the situation is that a collapse of price action below $27,193 would be a confirmation of a true market reversal and a true bear market which hasn’t been seen since the trading year 2018–2019 which could also fulfil the four year cycle “theory” if you believe in such things.
Having said that, a sustainment of price action above $27,193 and an ensuing sustained increase in price action would indicate the conclusion of a downward leg and the commencement of the upward leg which would then mean that the linear regression model remains, for the time being, intact.
Having talked a lot about the linear regression model and my usage of that model, let’s move on to the volume profile. In this case, I utilise a fixed point volume profile to measure the activity in price action across a given range, with that range being from January 2021 through to the current date.
The first major item to note is the value area which is the area between the two yellow dotted lines that seem, at first glance, to go up and down at random, however, you need to think of it as a rolling indication of a “fair value”. When the price action of an asset exceeds the top dotted line, the asset can be considered to be exceeding fair value and so, the likelihood of a retracement is increased. When the price action of an asset is below the bottom dotted line, the asset can be considered as discounted and will generally be followed by a major price increase.
To see this in action, let’s look at Bitcoin just prior to December 2021. We can see that Bitcoin was on a major leg up and spent 6 weeks outside of the value area where no fresh bids were supporting a continuation of upward momentum and thus traders and investors got spooked and a sell-off ensued.
Obviously this does not take in to account the other external factors that can affect price activity such as Covid-19 or surging inflation on economies which has been bruising traditional markets and does all add in to the pressure to investors whom are trying to move their wealth to secure havens. Let’s not forget that psychology plays an important part in how a market can behave.
At the current point in time, the price action of Bitcoin is within the value area which means that there will be a fair amount of uncertainty whereby the price can range between $30.7k (the bottom of the value area) and $53.4k (the top of the value area). We do have to take in to consideration the P.O.C — Point of Control, this is the point on the order book that has the largest collection of bid/ask orders. In this case, the P.O.C can be used as a rolling resistance and support level depending on which side of the market controls the action. To determine which group is in current control, we simply look at the numbers to the left side of the volume profile with the first group of numbers being the bids and the second group of numbers being the asks. We can see there is an almost even spread but the bids have the higher volume on the order book which is suggestive that the P.O.C is a form of weak resistance should the price action find it’s way back to the P.O.C.
The uniformity of volume at the current price action is really indicative of a high degree of price support from bids (buyers) which is a tell-tale sign that the price action of Bitcoin is approaching a “bottom” for the downward leg.
Alongside the linear regression channel and fixed point volume profile, I utilise three momentum indicators, namely the StochRSI, RSI and ATR indicators.
The StochRSI is used to help me identify relative trend direction in the first instance whereas the RSI is used to confirm the observation of the first indicator. In this instance, it is clear that Bitcoin is close to a switch in local momentum as the StochRSI is showing a potential crossover event and the RSI indicator is in a historically significant area where momentum reversals have occurred.
Normally, we can assume an asset to be “oversold” when the RSI level falls below 30 but few tend to remember that a move below 50 increases the probability of a momentum change. For example, Bitcoin is in a local downtrend, the RSI has moved below 50 and so the likelihood of a change in the local trend direction increases which means that a bounce of price is that much more likely.
The last indicator I use is an ATR — Average True Range. To use this indicator effectively, I look for significant areas of range changes in the price action which is reflected in the ATR.
Aggressive buying or selling results in noticeable peaks on the ATR whereas when the ATR flattens, we often see either ice-berg orders being implemented or we see retail traders and investors controlling market direction. Currently, the ATR is once again flattening out and that is occurring on the current downward leg which informs me that the local downward momentum is either being carried down by iceberg ask orders or “weak hand” retail traders/investors. In either case, my outlook remains positive until the linear regression model is invalidated and I am forced to reassess the market condition.
With regards to my end of month targets for January, they are as follows:
Upper Target — $69,700
Median Target — $51,030
Lower Target — $32,299
The most likely case is that price action will continue to range between $32,299 and $51,030 but ultimately, my expectation is that the price action will eventually exceed $51,030 by the end of Q1 2022 and my outlook for the entire year is a close of trading that sees the price range between $90k — $100k.
