Bitcoin Trading Notes: Market Momentum and Spread Trading

Bitcoin’s latest price climb has garnered quite a bit of attention, breaking all time highs and leading many to declarations of a bubble. While the price and resultant media storm have been enjoyable to watch (particularly for bitcoin holders), the markets have also offered a number of more nuanced dynamics worth noting.

The BTC / USD rate remains more than twice what it was just one month ago after a series of dramatic climbs beginning in mid-October. This weekend in particular saw quite a bit of notable activity as BTC / USD fell 26% from $360 to $260 in just eight hours before recovering to $335 most recently. Though there are significant underlying fundamental differences behind the bitcoin economy now relative to similarly dramatic gains in the past, a number of market signals are worth noting.

Market Momentum

Though bitcoin has climbed more than 2,200% in 2013 alone, a series of significant drops have occurred along the way. Timing the exact peak of a price climb can be difficult, but occasionally there are indications that the bitcoin market is getting close to such a point. Just over two weeks ago we pointed out what historically unsustainable momentum looks like by looking at 10-day price velocity. This weekend saw a similar scenario, with the metric reaching >0.5 on Saturday, a level only seen in the final days of the June 2011 and April 2013 bubbles and followed by a significant correction thereafter. Incidentally, the latest 26% drop in BTC/USD occurred the day after that level was reached.

price velocity

While the most recent drop may have relieved some short-term pressure, longer-term trends are still indicating outlying conditions. The 30-day moving average daily price change recently climbed above 3%, which has only previously been seen in what most would consider bitcoin’s historic bubbles: Jan 2011, June 2011, Jan 2012, and April 2013. Additionally, bitcoin’s logarithmic exchange rate growth has grown linearly for years as one of the most consistent trends since the currency’s inception and we’re now trending notably above that line, albeit not nearly as far as in April.

historic growth

Mt Gox – Bitstamp Spread

Over the last few days, one of the most tradeable trends has been the spread between prices on Mt Gox and Bitstamp. We noted at the end of October has as volatility stays elevated, the differential between rates at the two exchanges has fallen from 10% to 5-6%. As the graph below shows, occasional spikes into the low double digits after large rate movements are creating opportunities to take advantage of market latency.

When those spike occurred, anyone set up to trade on both exchanges could play the discrepancy by buying/selling the latent exchange as appropriate, though this would require comfort with the assumption that the other exchange would necessarily follow the rate movement. Alternatively, selling on Mt Gox and buying on Bitstamp creates a rate-neutral trade that bets only the spread between the two tightening back towards the norm. Costs are doubled in this strategy, but with the spread volatility and consistent reversion towards 5% over the past days, it would be more than recouped in a single well-timed trade.

Incidentally, the spread even inverted briefly. On the morning of November 7, a 10K BTC ask wall on Mt Gox made any price climbs led by Bitstamp or CNY movement unmatchable for hours.

exchange spread

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