Bitcoin: Trading a virtual currency

Have you heard of Bitcoin?  If you haven’t, here’s a quick overview.

Bitcoin is a kind of currency, but it isn’t backed by any government.  Instead, it’s generated, tracked and traded electronically, peer-to-peer, without any intermediate financial currency.  It’s based on an extremely complex encryption algorithm. The servers that keep track of Bitcoins are called bitcoin miners, and these servers also create new bitcoins electronically (but quite slowly).  Wikipedia has a really good article on Bitcoin, as they are known to do for techie types of things.

Here’s a few interesting things about Bitcoin: you can trade it like any other currency.  So, several small brokers allow you to trade Bitcoin against other major currencies like the Dollar and the Yen.  One brokerage, AvaTrade has been making the news recently as they allow you to trade Bitcoin with Metatrader 4, but it appears they are not licensed to operate in the US.  There may be other brokerages that operate in the US that offer Bitcoin.

Another interesting fact is that a court case in Texas just ruled that Bitcoin can be treated legally like a currency.  The case involves an individual who committed fraud in the form of a Ponzi  using Bitcoin.  The judge noted that Bitcoin is more like a precious metal than a currency, but the fact that it has value legally is interesting.

Another interesting point is the volatility of the currency.  Just read the Wikipedia article to bitcoin-chartssee how far the value goes up and down:  $13 at the beginning of 2013, then $230 in April of this year.  If you’re looking to trade a really wild currency, maybe this is the one for you.One of the confusing things about looking at the Bitcoin charts is that there are dozens of “markets” or actually brokerages that trade Bitcoin with other currencies.  They appear to have different slightly different values for Bitcoin.  (Maybe an opportunity for arbitrage?)  But if you want to trade Bitcoin on Metatrader, you pick a broker that supports both, set up your charts, do your technical analysis, and even run automated strategies on it.  This sounds like fun.

Have you traded Bitcoin?  Have you used a trading platform? If so, what’s your experience been like?

 

What Are Shallow Risk and Deep Risk?

A few days ago, I read an article in the Wall Street Journal by Jason Zweig titled “’Shallow Risk’ and ‘Deep Risk’ Are No Walk in the Woods.”  I like Zweig’s writing; his Intelligent Investor column always has something interesting to say.

In the article, Zweig describes an upcoming e-book by William Bernstein in which he describes two kinds of risk—obviously, shallow and deep.  Shallow risk is a temporary drop in an assets price.  It’s the normal ups and downs of stock prices, particularly when the price of the asset drops.  Zweig says (and I agree) that shallow risk is as inevitable as the weather.   Although shallow risk can definitely be painful and can last a while, it’s just not permanent.

Deep risk, on the other hand, refers to risks that are systemic and permanent; Bernstein cites 4 possible causes of deep risk: inflation, deflation, confiscation and devastation.  In other words, big bad things that can happen. Devastation and Confiscation refer to wars, government collapse, seizure of assets and so on—bad things that are out of our control.  Deflation is rare in modern history, so the only remaining concern that you can protect yourself from is inflation.  Zweig, quoting Bernstein, says that the best insurance against inflation is a globally diversified portfolio.

The thing that I thought most interesting about the article is where Zweig indicates that traders and investors can turn shallow risk into deep risk. How’s that? If you watch a trade go against you, and see your equity drop, you are experiencing shallow risk.  If you panic, and sell at the bottom, you inflict a permanent loss of capital on yourself.  The shallow risk is now permanent.  That’s deep risk.

 

My Favorite Forex Book

One of the first books I read on Forex trading was John Person’s Forex Conquered.  I was just re-reading parts of that book this week, and I wanted to highlight some of the best parts of the book.

John Person has a whole section on Trading Systems in which he explains how some of his tools and strategies from earlier in the book can be applied to automated trading systems.  Person’s strategies are excellent for automated systems because they are clear-cut; he has discrete rules for entries and exits, as well as for profit targets and stop losses.  In fact, the almost every chapter of “Forex Conquered” has knowledge that can improve your automated trading systems.

Person has a couple trademark tools he describes in almost all of his books: Pivot Points, seasonality, and the Doji chart pattern.  The Trading Systems chapter covers Pivot Points, and touches on seasonality with respect to automated systems.

Person takes three separate automated trading systems and compares their results.  He first explains a system that uses Pivot Points and the Stochastics Oscillator; he describes the system’s sell logic in that it waits for price movement through Pivot Point R1, R2 or R3, and then looks for the Stochastics Oscillator to cross up over the 80 percent level, and then back down over 70 percent level.  (Buy signals are similarly calculated.)  He also explains some of his thought process on setting stops, and reasonable profit targets.  And best of all, he provides some actual code to look at.  In this example, he shows the system written in TradeStation’s EasyLanguage programming language.

At the end of this section of the chapter, Person presents some statistics showing net profit, profit factor, winning percentage, and the standard stats you would expect to see from a trading system.  Just for a point of reference, the Profit Factor of this system is 1.86.

The second system that Person explains is one that uses Pivot Points and the MACD histogram indicator; the program logic is essentially the same as the Stochastics program, with just the indicator switched to the MACD.   Again, Person presents the statistics for the MACD version, and compares the results with the Stochastics version.  The Profit Factor for this MACD system is 1.35.

He concludes that the Stochastics version is a bit better, because the MACD’s signals lag a bit behind the price movement, and thus we are not able to enter a trend at the beginning or exit at just the right time.

The third system Person looks at is his Moving Average Pivot Point system (which he calls Defcon III). This is his trademark system, and it has served him very well over the years.  When Person teaches trading to new traders, the Moving Average Pivot Point system is usually a part of it.

John Person describes much of how the moving average automated system works, and gives nice hints as to how it should be programmed.  However, he does not provide code for this system, and in a conversation with him last year, he mentioned that was intentional.  It’s left as an exercise for the reader.

I spent some time writing this system for Metatrader 4, and it is working quite well.  It’s not perfect yet, and I need some more time on it, but I like the results I see.

At the end of this chapter, Person shows the statistics for the Moving Average Pivot Point system, and as you might expect, the stats are much better for this system, compared with the other two.  The profit factor for this system is a nice 2.03.

Even though the book has been out for a while, if you haven’t read “Forex Conquered”, I recommend that you do.  The Pivot Point Moving Average system is explained in a number of chapters throughout the book, and I believe the concepts should be part of every trader’s toolbox.