The 2 Golden Rules of Crypto Investing
Nobody knows what the price will be.
It doesn’t matter how much time you spend researching, how promising the projects and the teams are, the amount of hype on Reddit — at the end of the day, it’s impossible to predict future price movements.
The only thing you can do, however, is manage risk. While risk can never be eliminated, there are a couple of things you can do to help manage it:
- Diversify. In short, don’t put all your eggs in one basket.
- Don’t try to time the market. Trying to time the market has proven challenging — and could cost you.
This is nothing new — in fact, those techniques are as old as the stock market. Mutual Funds and ETFs have been employed to diversify investments for many decades now.
What we are missing is the discipline and tools to apply those investment methodologies automatically to cryptocurrency markets. We are building ChainCapital to fix that.
Diversify
“Don’t look for the needle in the haystack. Just buy the haystack” — John Bogle, founder of Vanguard
Predicting which cryptocurrency will be the next big thing is impossible. A few will hit the jackpot, but for most, not so much.
The goal of diversification is not necessarily to boost performance — it won’t ensure gains or guarantee against losses. What it will do however is prevent a bad investment from ruining the returns of the entire portfolio and increase your chances of picking a winner.
Let’s see an example of diversification in action. First, we are going to simulate a $1,000 investment all in Bitcoin made on December 1st. To do so, I will be using ChainCapital Simulator, a tool capable of backtesting investing strategies.
Today, our investment would be worth $841. That’s a 16% drop.
Now, let’s compare that to the performance of a diversified portfolio. In this example, we are going to pick 5 different cryptocurrencies among the top 20 by market capitalization that have been around for about 3 years or more:
- Bitcoin (BTC): 20%
- Ethereum (ETH): 20%
- Ripple (XRP): 20%
- Litecoin (LTC): 20%
- Stellar (XLM): 20%
Rather than dropping in value like Bitcoin, this portfolio increased by 133% for a total value of $2,328. This is because the drop of Bitcoin was offset by the rise of other assets.
Now, let’s zoom out to September of last year until today and compare the performance of this diversified portfolio against Bitcoin over time.
Even though Bitcoin is doing great, our diversified portfolio is performing much better. Diversification gives you a greater exposure to the overall cryptocurrency market, effectively hedging against one single bad investment.
While you may not like the choices made above, the key is to pick diverse assets and spread among them —then stick to the plan.
Diversifying doesn’t mean you can’t invest in a new project which you believe has great potential. Just make sure your moonshot category doesn’t represent an uncomfortable percentage of your portfolio, depending on your risk tolerance.
Don’t try to time the market
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves” — Peter Lynch
Buy low, sell high. Sounds easy, right?
In reality, trying to time the market is a risky game. We are driven to buy when the prices go up because of the Fear Of Missing Out, and to sell when the prices go down to cut our losses. Eventually, we end up buying high and selling low. It’s human nature.
Beside human emotions at play, the fact is consistently timing the market is simply impossible to do in the long run.
“…and the lesson about timing is: not only do you not know when to get in, you don’t know when to get out. And when you market-time you got to be right twice. You got to know when to get out and when to get in. And nobody and I really believe this: nobody but nobody can do that.”— Burton Malkiel in A Random Walk Down Wall Street
We might get lucky once or twice but in the end timing the market is not sustainable.
Instead, one should ignore short-term market movements, define an investment strategy and stick to it.
A common method to avoid buying at the “wrong” time is Dollar Cost Averaging. Rather than investing a lump sum at a time that seems favorable, we spread the investments over a period of time.
Let’s take the diversified portfolio example from above (BTC, ETH, XRP, LTC, XLM) and assume we invested $1,000 all at once on January 1st, 2018 — right before the mid-January crash from which we haven’t fully recovered from yet:
Today, our portfolio would be worth $624 — an alarming 38% decrease in value.
Now instead, let’s run a simulation but instead of investing $1,000 all at once, we are going to invest $60 every week:
In the end, we end up investing $1,020 and our portfolio sits at about the same value at $1,034 (+1%).
We effectively ended up consistently “buying the dip” and avoid a big down turn.
Conclusion
You can’t avoid risk — especially in a speculative market like crypto currencies. However, you can manage it by following two rules:
- Diversify to spread the risk.
- Don’t try to time the market: No one can.
Define an investment strategy that suits your specific needs, follows those 2 simple rules and, most importantly, stick to it. Don’t let emotions cloud your judgment. If possible, automate your strategy to eliminate human psychology from the equation.
Risk Management with ChainCapital
While those concepts are simple, implementing them can be time consuming and requires a lot of manual work and discipline. At ChainCapital we are working on a platform that completely automates the process.
Sign up for an invite here: https://chaincapital.io
Simulations shown in this article were built using ChainCapital Simulator.
