Bitcoin’s Power Law Oscillator pt.2: when can we expect a bottom?

  1. Quick Recap
  2. Where we are
  3. How does this help us?
  4. Dubious speculation
  5. Where this fails

A few months back I wrote an article explaining Bitcoin’s Power Law, how to construct the oscillator using python, and suggested a better way of analyzing the data that was presented to us. Give it a read to see how it works, or check out a recap below.

The article was written during what everyone generally agreed to be a bull market, but now that it is May ’22 and prices are back at May ’21 bottom levels, I want to analyze the indicator and talk about what the future could hold based on the indicator itself as well as other macroeconomic factors. Let’s dig in.

Quick Recap

The oscillator is an indicator whose value swings from -1 to 1. A power law is used to show the relationship between price and time. The oscillator is based on this and can be used to check if Bitcoin is currently overvalued or undervalued, and by how much.

Where we were

As I was writing this, I went back and checked what the price of Bitcoin was when the previous article was published. Turns out the 8th of November 2021 was the highest daily close for Bitcoin ever… I ironically managed to time the exact top (maybe publishing this article will manifest a bottom?). Anyway, this is what the oscillator looked like then.

Power Law Oscillator on Nov 8, ‘21

I made 2 observations at that time — first was that even though the oscillator value did not reach into the red zone in May ’21 as it has done previously during tops, it did cross the 90th percentile (marked in yellow), which should have made us cautious (in hindsight). The second was the presence of an imaginary trendline, pictured below.

Following a trend line? (Nov ‘21)

The general assumption in November was that the worst was over and the second leg of the bull market was underway. And that the price of Bitcoin would soon reach $100,000. If you had asked me what the oscillator would look like, I would have drawn something like this.

This did not happen

Where we are

So… none of that happened. This is what the oscillator looks like now.

May ‘22

The trendline did not hold as expected. The oscillator value has just dipped below 0 for the first time since 2019. It has also gone below the 50th percentile.

What this means is that if you draw a linear regression line through the log-log plot of Bitcoin’s price vs. time, the line lies above the actual price of Bitcoin at this moment in time. Some would say Bitcoin is now undervalued. The green shaded zone was marked out as the accumulation phase.

In the previous post, I also alluded to identifying what is referred to as “non-bubble” data. As you can see below, it looks like we are entering a similar phase again.

“Non-bubble” data in red

How does this help us?

In the previous article, I also suggested that viewing the price of Bitcoin color-coded with percentile values could help us in some way. In January of 2022, I made the following observation:

First green dot for a long time

That was the first time the oscillator value dipped into the 60th percentile band for a while. The last time color changed from red to green — it eventually went to dark blue.

Also, the new all-time highs in November 2021 were not “blow-off top” and did not show up as deep red, but only as bright red. Red still indicates that it is overvalued, though. This made me think that it was possible that November was something like a “dead-cat bounce”. Now, I am aware that that term isn’t exactly used for when the price goes on to make new all-time highs but in terms of oscillator values, it felt interesting. I felt we would at least touch the trendline in the coming weeks.

January oscillator values signaled caution

Of course, you could never take such illustrations as proof to the bank. Most of this is hindsight. A lot of people expected the price of Bitcoin to hold and then reverse at around $40,000 and then around $30,000. This did not happen. Turns out the answer to “bottom or pre-bear?” was indeed pre-bear!

Red -> Green eventually brings Blue

Dubious speculation

I think this means that the worst is yet to come for Bitcoin. That doesn’t mean we can’t bounce temporarily. However, the best time to buy and hold Bitcoin has historically been when the indicator flashes blue. From here, that can happen in 2 ways.

Either the price of Bitcoin could keep falling at a reasonably quick rate, or it could stay stagnant for many weeks— until time catches up. In both scenarios, it makes little sense to immediately start buying with a long-term outlook.

Throw in terms like interest-rate hikes, inflation, monetary policy, and tightening and it seems like there is a long way to go before markets recover. I am not an economist so it doesn’t make sense to comment on these topics — but if the oscillator says it might be a wise idea to wait for blue, I will wait for blue.

I personally feel the price of Bitcoin could eventually go much lower than $30,000 considering how crazy everything in the world is at the moment, but that’s just me. It will be interesting to see where the oscillator would be if the price falls to around the $16,000 — $24,000 range.

Where this fails

Every reasonable indicator has some basic assumptions that could break and we should talk about them. This one is quite simple. Our oscillator values are based on price vs time. So far, the price of Bitcoin has generally trended up with time. That means when the oscillator value is low, it means the price is low. And when the oscillator value eventually increases, it means that the price will also increase.

However, Bitcoin has not existed during a macro bear market. A decade of price moving only upwards may have lulled us into thinking price will keep moving upwards, and that might not be the case! If the price gradually starts moving downwards for multiple years, an increase in the value of the oscillator may not necessarily correspond to an increase in the price of Bitcoin! In other words, price when color is blue could be greater than price when color is green.

Cycles, and so on

The great thing about this article is that if we do indeed bottom at current levels, I can say that my publishing this article caused it. And if we go lower, I can claim I predicted it in this article.

You can always follow me for more incredible analyses like this! Thanks for reading. I’ve also updated the code to do all this in python. Do check out the previous post for a detailed explanation. If this indicator flashes blue in the next few months, I will write a pt. 3 as well.