Pick One Poison & Learn to Love It
Relative Stability in a Sea of Cryptocurrency-Volatility
As an initial observer and, more recently, trader in Blockchain based assets for a good portion of 2016 and 2017, I penned this piece to share my experiences among the community. I trade primarily on Bittrex.com, Coinbase’s GDAX and through initial coin offerings (ICOs) by different Blockchain start-ups across a range of industries. Trading in this space essentially means engaging with digital currencies through 3 scenarios:
-Initial coin offerings
-Long positions on digital tokens/currencies
-Day-Trading a single or a range of different tokens (alt-coins)
The main focus of this piece is to highlight my process in the third listed option; day trading.
The high volatility within the cryptocurrency world makes it a prime option to realize significant gains over very short periods of time, sometimes as short as a few minutes or less. In this regard, I began trading with a basket of different cryptocurrencies chosen on the basis of preliminary examination of the financial models, team, vision and forum ‘buzz’ around these tokens but I was quickly deterred from managing a basket of currencies, primarily because I was trading these coins by pairing them with Bitcoin as the base currency. With bitcoin being as volatile as it is, this form of trading required me to consider price movements on two fronts simultaneously as one would need to monitor bitcoin price movement and the chosen token’s price movement in conjunction with a number of quantitative and qualitative indicators. It is true that there is a very high correlation between these alt-coins and Bitcoin, but considering the low volume that a majority of these tokens experience on a daily basis, they are subject to significantly higher potential price variance. The low volume in these coins also makes them prime targets for ‘Pump and Dump’ campaigns.
These constraints led me to consider a strategy focused on a single coin’s movements without the need to constantly monitor the base currency as well. Coinbase’s GDAX offered the perfect solution in this regard with the ability to trade Bitcoin, Ethereum and Litecoin directly with USD, offering no transaction fees on limit orders. While initially starting to trade all three of the offered options, I found that stability in earnings comes most easily with a focus on a single currency. And the coin I chose was Litecoin. Priced lower than both Ethereum and Bitcoin, I gained the ability to purchase multiple coins and thus multiply the gains per coin over the coins purchased.
This focus allows you to develop a unique understanding of the temperament of the coin. And I use the word temperament because understanding the price movement of a single coin is almost like understanding a person. (or technically, the collective sentiment of the aggregate investor base for that coin.)
So, How do you understand a coin?
-You follow the developments in the digital coin as and when they’re announced.
-Research the credibility of the development team, follow them on Twitter. Read their releases.
-Which markets have the highest volume for your coin of choice?
-What potential regulations could impede its growth and the proliferation of Bitcoin?
-What new false statement did Jamie Dimon make about Bitcoin?
-What time do Chinese markets wake up relative to your timezone? What about US markets, Japanese markets?
-You need to dedicate time and attention to its price movement across different time intervals. With time, you gain some measure of understanding of what price growth movement seems organic and what will prompt a kick-back by investors, holding Bitcoin relatively constant. This is done in conjunction with a number of technical indicators. In my case, I use the relative strength index, the Bollinger bands, the squeeze momentum indicator and Bitcoin price correlation with the coin of choice. All these indicators are considered over the 5, 15 and 30 minute time intervals, which I opine to be the ideal ranges considering the high volatility in price for these more established Blockchain currencies.
(I don’t like the word crypto-currency; it attaches a negative connotation to digital tokens that are paving the way for the best business practices for the future).
Setting return targets plays a significant role in how I allocate my time towards trading a digital coin. With a target of between 10–15% return each month, I have a fixed dollar amount I need to gain each day through my trades after which I stop trading completely for the day. This decision helps me combat the FOMO (Fear of Missing Out) in missing an uptick in price beyond my order sale price since I’ve hit my target return for the day and, am thus, on track to hit a very comfortable return for the month. One does really pay quite dearly to be greedy in a sea of high crypto-volatility.
Combating Downside Risk
As is the case with any market, there is downside risk and I employ different methods to minimize my exposure. First off, I set a percentage of my trading balance as a reserve (~25%) which is only tapped as a means to maintain daily targets should the market experience unexpected and significant fall in prices while I hold Litecoin at a higher price.
If the price fall isn’t too significant, this reserve can be used to “rescue” your initial position by bringing the dollar cost average down enough to sell with lower/minimal/no loss if the price recovers. In addition to the reserve, it is important to go in with smaller percentages of your trading balance for a single trade or trades within a narrow range of prices. This combats downside risk and would allow you to meet your daily targets over a number of trades over the course of the entire day and allow you to have liquidity to lower your dollar cost average should the need arise. In the rare case that the loss does not seem easily salvageable, I use initial coin offerings as a final hedge. After evaluating an offering that closes in the near future, I transfer funds into said offering. ICO tokens have a fairly positive track record in their initial introduction to the broader public markets. I have been able to successfully recover major losses on day trading through the few initial coin offerings I’ve had to engage in as part of a loss recovery effort.
My Trading Screen
As far as combining inputs for making trades, this is what my trading screen looks like. I use TradingView, which offers a comprehensive interface for free. This uses candlesticks over 5 minute intervals. The topmost chart has the Litecoin candles with the Bollinger bands and the Bitcoin price area chart in the background. The second frame is the relative strength indicator and the final frame is the squeeze momentum indicator.
The inputs from the RSI indicator and Bollingers bands are fairly straight forward to interpret. I’ve grown increasingly fond of the squeeze momentum indicator in picking up signals based on momentum cycles.
The Temperamental Relationship with Bitcoin
The hardest aspect that I’ve found is making decisions in conjunction with Bitcoin price movement. Bitcoin defines price movement for all Blockchain currencies across the board. It is the benchmark, the Beta = 1. And each Blockchain currency displays different reactions to Bitcoin movements at different times with no clear unifying driving factors behind these divergences.
The above image highlights one such occurrence out of dozens that take place daily: With Litecoin in red and Bitcoin in blue, we see a divergence in their patterns following almost perfect mimicry leading up to it. This situation injects additional uncertainty to the a mix that is already highly speculative; perhaps Litecoin has preempted a possible BTC drop, or Litecoin is lagging behind the market as volume is distributed to Bitcoin or a number of other scenarios. Volatile Bitcoin price movements render the standard trading indicator irrelevant especially when the degree of correlation varies so significantly.
This relationship makes trading decisions difficult in periods of high Bitcoin volatility where Litecoin displays different degrees of correlation for rises and falls in bitcoin with a higher correlation right after a significant dip in Bitcoin than for a significant price spike. There is a possibly related trend in equity markets as well where it has been documented that negative earnings responses/news prompts a stronger negative trend in share prices relative to the price surge upon receiving positive news. Boiling down to human psychology, this pattern in Litecoin, may be attributed to the basic idea that people hate bad news more than they like good news. Individual investors probably believe that other panicked investors are selling their Litecoin upon seeing BTC price drop and thus go ahead and panic sell their own Litecoin, contributing to the self-fulfilling prophecy of Litecoin following suit immediately with Bitcoin’s price drop, but in a price surge, this behavior varies; usually there’s more of a lag between price movements, perhaps due to the lack of panic and potential loss, accompanied by inertia by new investors in picking up an asset that is growing more expensive now (and could possibly drop much lower in the very near future).
At the outset, I’m certain someone out there has developed a more quantitatively sounds approach to combat the risk elements identified above but for the uncertainty I’ve discussed, I have managed to maintain a relatively stable 7–9% monthly return. I’m constantly learning on a learning curve that is still relatively steep. It’s an exciting new world out there and my choice of poison hasn’t killed me yet.