Bitcoin, bitcoin, bitcoin…
Mere mention of the ‘b’ word is enough for me to tune out. Chatter about the crypto and its digital cousins seem to be everywhere.
You can probably guess I wasn’t an early adopter.
But I came oh-so close.
You see, a friend had a situation…
His business fell prey to hackers early last year. The cyber crooks would only unlock his computer network for a ransom — two bitcoins, worth about $2,000.
My friend made a quick decision to pay. He reasoned that the ransom was small in comparison to the cost of doing nothing.
But buying bitcoin can take a while. You need to set up accounts and transfer money. This gave my friend the chance to try his hand at negotiating.
And it worked…
By the time the ransom payment was ready, the hackers had lowered their price. The final amount was one and half bitcoins — a saving of about $500.
Now here’s the thing: My friend had placed an order for two bitcoins. But thanks to the last-minute discount, he was left holding half a bitcoin.
My friend asked me what he should do with the remaining crypto. I told him I didn’t know much about bitcoin, but that the trend was up and that he should hold.
This brings me to my close encounter…
After seeing the price action, I decided to throw in $10,000 myself.
But rather than put it all on bitcoin, I checked in with Port Phillip Publishing’s crypto expert, Sam Volkering.
His top three selections were bitcoin, ethereum, and ripple.
Excellent, I thought. I’ll put a third in each.
And that’s where it ends…
I never got around to finding an exchange or setting up a digital wallet. A six-figure win went begging.
As they say: Close, but no cigar.
My friend did a lot better. He got out soon after bitcoin’s fall in late December. Thanks to the cyber bandits, the overall experience left him $4,500 better off.
Step back in time
I’ve seen some runaway markets over the years. But nothing comes close to the crypto boom. I still kick myself for not buying a stake.
That brings me to this week’s topic…
Suppose you knew for certain that bitcoin’s price would rise 1,900%. How would you use this information to make the most money possible?
Now, there are multiple ways you could trade this knowledge.
But I’ll narrow it down to two choices:
- You could buy bitcoin outright; or
- You could use a CFD (Contract For Difference) to get leverage.
Check this out:
[Click to open new window]
This is a bitcoin price chart. It covers the period from late 2013 to the recent peak.
You’ll notice that there’s a big chunk of data missing. Don’t worry about that right now. I’ll tell you why I’ve covered it up in a minute.
Now, suppose you could buy bitcoin where I’ve marked on the chart — for $1,000.
And you know you could sell it for $20,000 in December 2017.
How much would you buy?
Remember, there are two options:
- Buy bitcoin outright; or
- Use a CFD to get leverage.
I saw one CFD provider offering a product with leverage of 25 to 1. This means that, for every dollar bitcoin moves, your account’s value changes by $25.
For instance, if you buy one CFD when bitcoin is $1,000, and sell when it’s at $20,000, you’ll pocket $475,000. Let’s assume you have access to this product.
Now, think for a moment…
The price rise is a certainty.
Do you play it safe or leverage up with CFDs?
Just for fun, work out a hypothetical trade. Use your capital base to decide how much bitcoin — or how many CFDs — you’d buy. It will be interesting to see how this plays out for you.
$20,000 or bust
OK, let’s see how the trade goes:
[Click to open new window]
There’s no surprise with the result — bitcoin rises from $1,000 to $20,000. If you bought the crypto outright, your account would be up 1,900%. Well done!
But what if you chose to use leverage?
Well, you’re potentially up $475,000 per contract.
There’s just one question: Were you able to hang on?
Yes, you knew bitcoin would hit $20,000.
But you didn’t know the course it would take to get there.
Look at the decline that follows the entry point — bitcoin falls by $829. The price hits a low of $171 in January 2015. That’s a drop of 83%.
Now, this isn’t an issue if you paid for your stake in full. You know the fall is temporary. All you need to do is ride it out and wait to collect.
But it’s not so simple if you use leverage…
You see, CFD providers adjust your account daily. They add money when prices rise, and they make withdrawals when prices fall.
Do you remember the amount of leverage on that bitcoin CFD?
That’s right, it’s 25 to 1.
Let’s do the sums on one contract…
Every dollar bitcoin moves creates a $25 adjustment to your account. If the price falls $10, the CFD provider withdraws $250. If it falls $100, the hit is $2,500.
In this case, bitcoin falls $829. Multiply that by 25 and you get a loss of $20,725.
And that’s for just one CFD. How many contracts did you think of buying?
The CFD provider will let you keep the trade if you can cover the loss. But if your account runs out of funds, it’s all over. The trade gets closed. All you get to keep is the loss.
Even knowing the future doesn’t guarantee success when using leverage.
The simple fact is this: You can be the world’s best trader and have a heap of capital. But you still risk ruin if you use too much leverage.
The key is to be conservative.
Keeping your trade size under control is the best way I know to avoid a wipeout.
Until next week,
Jason McIntosh, Editor, Quant Trader
Editor’s note: Quant Trader isn’t just about buy signals — it’s also about learning. Jason, through his decades of experience, aims to give you the confidence and discipline to trade like a professional.
Each weekly update helps to develop your understanding. You can then make that knowledge your own by applying it to his system’s buy signals. That’s the best way we know to truly learn.
Quant Trader sources all graphs and images above, unless otherwise stated.