So you want to short bitcoin? Here’s your road map.

Do you think bitcoin is a bubble? Do you think the speculative crypto fever has broken? After last week’s price action, a lot of people—myself included—think the answer to these questions is Yes.

None of us really knows if this will prove to be the case. After all, bitcoin—the de facto benchmark in the space—has declined by 30% or more probably a dozen times since its inception, coming back stronger each time.

But this time feels different. It feels like a bubble. The fever in the post-Thanksgiving moonshot ran hotter than we’d seen before. We also began to see a robust supply response.  Bitcoin futures were also introduced, allowing investors to short or hedge their holdings for the first time. Maybe it’s a coincidence the ATH price in bitcoin came just before brokers allowed customers to short the futures last Monday morning, but I wouldn’t bet on it.

Bubbles are complex dynamics. What they all have in common, however, is they require emotion to truly go parabolic. Moreover, the less we understand the object of the bubble, the greater the scope for greed and FOMO to fill in the blanks. It’s much easier to make a bubble out of TSLA than it is out of GM.

Accordingly, we’ve seen a lot of creative crypto narratives recently. But scrutiny brings knowledge, and knowledge kills bubbles. And over the past few weeks we have started to figure a few things out.

1.  You can be simultaneously bullish on blockchain and bearish on bitcoin.

2.  The supply of crypto tokens is not de facto fixed. If prices hold up, a rush of upside-capping supply is almost a certainty.

3.  Even if crypto currencies settle down and eventually become an adoptable medium of exchange, it’ll likely be emerging tokens, not bitcoin that will win that race by being quicker, more efficient, and more practical

So, if you believe that we’ve likely seen the highs in bitcoin and you want to go short, how do you go about it in a responsible way?

First, bitcoin is volatile. It’s annualized volatility is over 100%, implying daily moves up or down of over 6%. Second, bitcoin exchanges are open 24/7, but bitcoin futures follow regular Globex hours. Third, the exchanges have integrity risk (e.g. Mt Gox) and the futures have 20% collars. These last two factors increase gap/discontinuous pricing risk for those who trade the futures, even though I suspect these factors represent more risk for long positions in bitcoin futures than for short ones.

In sum, you have to be extra careful with bitcoin in your sizing and risk management.

I see two ways to play a bitcoin short. First, the longer-term play. In my experience the smart way to play bubbles is to short when the momentum fades on the first bounce after the fever breaks.

Here are two recent bubble charts, the NASDAQ 1998-2002 and Silver 2009-2013.

NASDAQ 100 (Dotcom bubble) 1999-2002
Silver (precious metal bubble) 2009-2013

You will see that the charts of the NASDAQ and silver (precious metals) share a  basic pattern: parabolic, fevered top, followed by a sharp drop and then a weak, protracted bounce channel as investors attempt to “recreate the magic”.

So the long-term play is to wait until the momentum in the bounce attempt has faded and it breaks down out of the bounce channel. This could come a lot faster in bitcoin because arguably the understanding of the underlying asset is more nebulous and the illusion factor was higher. But you never know. You have to size it small and hope you make the right call on the entry point.

Nearer term, the opportunities to short seem cleaner. Here are charts of XBT intraday over the past 31 sessions, and daily, over the past year.

Bitcoin, intra-day, last 31 sessions
Bitcoin, daily, over the past year

You can see on both charts there is heavy overhead in the 15,000-16,000 area. Going up into that area and then breaking down from it would be a logical trigger for a short. You could then set your stop and position size based on some rule that defines a violation of that pattern (e.g. two closes back up into the bounce channel).

The other near-term scenario is where bitcoin tries to get away from you on the downside. Given the faith-based nature of the asset, it is entirely possible that we get very little bounce here, and bitcoin continues to tumble. The dramatic fall late last week took less time than it does to say “cold storage”, leaving a lot of trapped sellers. Moreover, we knew NASDAQ and silver weren’t going to zero, but we can’t say the same about bitcoin–at least not with anywhere near the same degree of confidence. The odds of a continuation selloff are high.

So this is what you can do. Bitcoin closed at 14,240 on Friday, after an intra-day low down near 11, 000. If we close below 14,240, you can short it, betting that the unwind is not over. Again, you have to set a stop that makes sense at that point in time, and size your position accordingly. And you need to be mindful that it is quite possible bitcoin will trade weaker when the futures maket is open than when it is not. But you should not be afraid to chase. If it is truly a bubble, and the fever has now broken, there is still a lot of potential downside–however viable you might believe the underlying technology to be.

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