Stock Exchange: Do Not Invest In Bitcoin, Trade It!

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods, including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review:

Our previous Stock Exchange asked: Are Momentum Trades Better Than Dip Buying? If you missed it, a glance at your news feed will show that the key points remain relevant. One takeaway from last week’s Stock Exchange was that a particular trading style works great, until all of a sudden it doesn’t. Dr. Brett Steenbarger likens this phenomenon to a strong tree that may crack when it gets windy, versus a bamboo or willow that survives by bending with the wind. There is a distinct regime in the current market. And when the momentum trade finally cracks, will you bend like a willow or crack right along with it?

This Week: Do Not Invest In Bitcoin, Trade It!

If you have strong valuation skills, you’re probably a horrible trader. That’s the common knowledge among many successful trading circles. For example, Renaissance Technologies, one of the most successful systematic trading firms of all time, “avoids hiring anyone with even the slightest whiff of Wall Street bona fides” (i.e. they prefer to hire mathematicians, physicists, and statisticians, for example). Similarly, Steve Cohen’s Point72 likes to hire people with non-finance backgrounds such as history and music.

Image source

Professor Aswath Damodaran (from the Stern School of Business at NYU) offers some invaluable insight into why traditional backgrounds in valuation don’t necessarily lend themselves to trading, in this article on Bitcoin: The Bitcoin Boom: Asset, Currency, Commodity or Collectible? Professor Damodaran explains that Bitcoin is not an income-generating asset that can be valued, but rather Bitcoin has characteristics of a currency that can only be priced. And as shown in the following table from Professor Damodaran, pricing means everything to traders, whereas valuation is often irrelevant to them.

Sticking with the Bitcoin trading theme, trader JC Parets points out an amazing pattern to Bitcoin pricing in this article: Fibonacci Analysis On Bitcoin. Specifically, Parets notes Bitcoin pricing has been following the Fibonacci Sequence “so perfectly that it’s hard for some to believe that this is simply normal behavior.” The Fibonacci Sequence is a mathematical phenomenon that has nothing to do with valuation, but has historically demonstrated itself relevant for traders with regard to pricing.

And for those of you with a background in long-term investing, not trading, Blue Harbinger offers five current ideas on how to place trades that fit your style in this article (hint: they’re all income-generating put option sales on attractive stocks that he believes are trading below their long-term value, meaning you keep the premium income generated for selling the puts no matter what, and if the shares happen to get put to you then you’re happy to pick them up at an even lower price).

Expert Picks from the Models:

This week’s Stock Exchange is being edited by Blue Harbinger (aka Mark Hines). And this week, we’ve included Bitcoin in a couple of our momentum model rankings (e.g. Felix and Oscar) to see how the cryptocurrency matches up against other trading opportunities within a particular universe.

Holmes: This week I bought Sally Beauty Holdings (SBH). Are you familiar with this company?

Blue Harbinger: Well, I know Sally Beauty is a specialty retailer and distributor of professional beauty supplies, but I am not a customer. They do hair care and color, nails, skin, accessories.

Holmes: Well the stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. And it has attractive upside over the next six weeks.

BH: Interesting pick Holmes. I have mixed feelings on this one. On one hand, Sally Beauty is a retailer located in shopping malls. People aren’t going to malls so much anymore because service stinks (in my opinion) and it’s easier to just buy stuff online. I believe comps have been mostly flat for Sally Beauty. But on the other hand, Sally Beauty still generates a lot of revenue and it’s consistently profitable. The contrarian in me likes to buy stocks that are out of favor. This stock’s price has essentially been cut in half since early 2016. For some fundamental perspective, here is a look at Chuck Carnevale’s very useful FastGraph.

Holmes: I am happy you’re considering the fundamentals, Blue Harbinger. But I am a trader, and my typical holding period is about 6-weeks, so I’ll be in and out of this one before the long-term valuation story plays out. I am attracted by the current price (i.e. it has upside).

BH: Tell us a little more about your trading style, Holmes.

Holmes: My style is based on dip buying and mean reversion. I’m really into protecting assets too. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of advanced trading techniques (including profit taking, stops, and trailing stops) and technical analysis to help protect if the stock price starts to fall too far.

BH: Like I mentioned, I see positives and negatives to this one. But I’ve been doing this Stock Exchange with you for several months now, and I see the success you’ve been having, even in our current momentum driven market. Let’s check back on this one in about 6-weeks (i.e. your typical holding period).

Holmes: Fine by me. How about you RoadRunner, what have you got this week?

RoadRunner: I like Netflix (NFLX) this week. As you know, I like to buy stocks that are at the bottom of a rising channel, and if you look at the chart below you can see why I like Netfix.

BH: In this momentum-driven market, I can see Netflix going higher, and I like your strategy of buying at the lower end of a rising channel. How long do you plan to hold Netflix?

RR: My typical holding period is about 4-weeks.

BH: Netflix recently posted another strong quarter of subscriber growth and revenues. Plus they plan to increase the price of subscriptions, and that may be a good sign (depending on how it works out) because according to Warren Buffett “the single most important decision in evaluating a business is pricing power.” Also, for your reference, here is a look at Netflix FastGraph.

RR: Thank you for sharing that fundamental information, but I am a trader. I’m most concerned with the current price versus where it will be in four weeks.

BH: I acknowledged I like your dip-buying within a rising channel strategy, but what are you going to do when the momentum trade stops working? Are you going to crack, or are you going to bend like a bamboo or a willow?

RR: I don’t let your touchy-feely fear tactics scare me. I have discipline, and I stick to my strategy. Besides, when combined with the strategies of some of the other traders (Holmes, for example), we deliver strong returns with a lower correlation to the market, so the big market shift you keep warning about is interesting, but we are ready.

BH: If you say so RoadRunner. Your approach has been performing extremely well lately, and I appreciate that. How about you, Felix, what have you got this week?

Felix: I’ve got a real treat for you this week. The following list is my top ranked Nasdaq 100 stocks, and I’ve added the Bitcoin Investment Trust (GBTC) to the universe because I heard you talking about it earlier. And compared to the most attractive Nasdaq 100 stocks, Bitcoin is even more attractive!

BH: Now that is interesting, Felix. I see you have some semiconductor stocks like Nvidia (NVDA), Micron (MU) and even Broadcom (AVGO) on your list of top ranked Nasdaq 100 stocks, but you like Bitcoin even more. Remind us, what is your process?

Felix: I am a momentum trader, as you might have guessed because my top ranked ideas have all been performing very well lately. I hold things longer than the other traders, 66 weeks on average. I exit when my price target is reached, and I control risk by monitoring macro factors and using stops.

BH: Honestly, I don’t know a lot about the cryptocurrency, Felix. Except that the talking heads and media pundits won’t shut up about it. Based on the price performance chart we shared earlier, I can say that Bitcoin is scary. And I have no idea how to value it because it doesn’t pay dividends or even produce any income.

Felix: You don’t “invest” in Bitcoin, you trade it! Didn’t you learn anything from Professor Damodaran’s table earlier in this report?

BH: Great, thanks Felix. How about you Oscar, did you look at Bitcoin this week?

Oscar: I did look at Bitcoin. I added it to my universe of US and emerging market ETFs, and as you can see in the following ranking, Bitcoin ranks at the very top (i.e. it’s very attractive).

BH: And what is your selection process Oscar?

Oscar: I am also a momentum trader, but my average holding period is typically about 6-weeks. I rotate into another sector when it’s time to exit, and I also use stops to conrol risk.

BH: I do find it interesting that Bitcoin ranks so highly in both you and Felix’s models, but I suppose I shouldn’t be surprised considering the current momentum-based market envirnment.

Conclusion:

Momentum trades continue to work very well. One such example is the Bitcoin Investment Trust as discussed in this article. However, it’s important to recognize that Bitcoin is not an income-producing investment asset that can be valued. It’s a cryptocurrency that can be traded based on its price. And Bitcoin’s dramatically climbing price is not inconsistent with the favorable momentum trading envirnoment we are currently in. However, market conditions can persist for a long time, but then suddenly change with the wind. And when the wind blows, will your trading profits crack like a strong tree, or will you be ready to bend with the wind like a bamboo or a willow?

Stock Exchange Character Guide:

Background on the Stock Exchange:

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/  for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates:

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

5 thoughts on “Stock Exchange: Do Not Invest In Bitcoin, Trade It!”

  1. Where can I find the specific risk control measures and exit points for the different models? e.g. for RR’s NFLX trade this week; where is the profit taking exit, stop, trailing stop, etc.?
    Thanks

Comments are closed.