Sell Bitcoin Ahead Of Futures Launch Says Algorithmic Expert
Source: Mark H. Melin
Sunday's launch of Bitcoin futures is the first opportunity institutional investors will have to sell.
It is unclear what will happen, but what is clear this is an unknown event.
Algorithmic trading systems typically get flat ahead of statistical outliers.
As the debate over the legitimacy of bitcoin rages, most of it might not matter. On Sunday bitcoin futures will start trading on the CBOE, which will immediately inject a degree of institutional legitimacy into the product.
That advent of listed derivatives to bitcoin will be meaningful from several perspectives. But most materially for traders, now might be a good time to sell based on my algorithmic analysis. Here is why.
Bitcoin algorithmic analysis has been challenging if not impossible due to the lack of institutional players
Providing algorithmic analysis on top of bitcoin has been relatively difficult, if not impossible – until Sunday, that is. Because institutional traders – in particular, global market makers who arbitrage the price to keep it consistent – generally haven’t been in the market. This was most recently put on display Thursday, when the price of bitcoin in South Korea was 23% higher than it was around the world.
To algorithmic traders, such wide spreads between markets is often a sign of an immature market, one where institutional investors have not arrived… yet.
Institutional investors can move bitcoin markets with a shrug
Currently, 40% of the bitcoin market is owned by just 1,000 individuals, according to a Bloomberg report which noted:
A few massive investors can rock it with a shrug.” The article went on to note that the “few hundred guys” that drive bitcoin pricing “probably can call each other.
In an unregulated, global cash market, collusion on positioning among major players is a realistic possibility that anyone trading bitcoin must consider.
The low dispersion of ownership percentage is likely wetting institutional investors’ appetite as they are likely to reshape these markets to their liking – and the resulting price action will reflect this in specific ways should it occur.
When institutional investors do arrive, bitcoin will be analyzed from an algorithmic standpoint just like any asset.
For one, the nearly parabolic price rises are likely to become more muted. With institutional players, I would expect to see a more rationale regarding price movements that go beyond the logic that currently exists, one that comports with their ability to lay off risk and create a delta neutral portfolio position.
But perhaps most importantly, institutions and their algorithms are going to drive prices. The same organizations that drive prices of currency, agricultural and financial products will now use basically the same formulas with bitcoin. It is logical to think institutions are likely to become the predominate traders of bitcoin, particularly after the CMEGroup launches their contracts, followed by NASDAQ and Cantor Fitzgerald.
While there is very little if any detected collusion among major institutional players in listed derivatives, it should be noted that many of the trading and market making algorithms operate on a generally consistent set of core principles. While all algorithms are confidential, as someone who has written a few books in the space, taught a course and has consulted on algorithmic strategy, it is my observation that algorithms are generally considering factors regarding beta market environment analysis for momentum, volatility and relative value properties. How these factors play into a formula is going to vary, but generally speaking, I have yet to run into an algorithmic trading firm that doesn’t consider these factors in how they make markets or even directionally trade them.
So what does this mean for bitcoin traders today?
Take profits in bitcoin for these three reasons: Sunday's futures launch is an unknown event, mean reversion after a strong price run-up is possible, institutional investors could flex their muscles
I would be selling into Sunday’s introduction of futures by the CBOE for several reasons.
First, there is an algorithmic trading concept called ambiguity aversion. Traders often look at market events and categorize them based on their assumed potential volatility impact. You can see this in how algorithms price individual stock options just prior to an earnings announcement: the volatility premium is significantly higher than after the announcement.