(The code for this article is available on Github in the pantera Jupyter Notebook)
I consider myself to be a bitcoin investor. Some very smart people (like Warren Buffet for instance) would probably retort that there is no such thing as investing in bitcoin, and at very best you are speculating. In spite of this I consider bitcoin an investment because I believe you can reason about it’s value in the future and can assign rough probabilities to the possible future outcomes. To me that does not seem very different to the way an investor would reason about the future value of a company and what the future outcomes and rough probabilities are. In both cases if you find that the probability adjusted value is likely to be much higher in the future than what you can buy it for today then this could be considered investing.
There’s another, more personal reason, that I invest in bitcoin. I beleive the world is a better place with bitcoin than without it. We’ve had a monopoly in money for too long, so it’s heartwarming to see a new (and in my mind better) form of money emerge organically that is based on the voluntary co-operation of free individuals rather than on the use of force. I consider it something of a miracle that bitcoin has gotten to where it is today, and I would like to see it continue. People can surely decide for themselves what money they find best, and also what is useful as money for them. After all money is a social tool.
I’m writing this article from the perspective of someone who has already decided to invest in bitcoin, and wants to explore different tactics and strategies for how to make the investment over time. For those that have not yet decided, I suggest starting your research by reading The Bullish Case For Bitcoin. If you want to balance that out with a diametrically opposed view then read anything written about bitcoin by Josph Stiglitz (an authoritarian economist with no skin in the game who is afraid that allowing people free choice in money will somehow be bad for society so wants to use force to prevent it).
My goal with this series of articles is to determine whether I can find strategies that improve on the buy and hold return for bitcoin. This is a really tall bar, since the buy and hold return has been incredible. First I will try and show whether this can be done in theory by looking at past prices and testing different strategies, and then I will attempt to do it in practice. I’ve previously written about Why HODLing Bitcoin Will Make You Miserable (but do it anyway) and Bitcoin Price Exploration (Part 1) Why Most People Shouldn’t Trade It. I’ve also been looking into a A strategy for trading ETH to make more BTC.
In part 1 of this series I’m going to look at a strategy loosely proposed by Dan Morehead of Pantera Capital (Dan has the same first name as me, so I can only assume he’s a really great guy). The strategy goes something like this.
Bitcoin almost never trades lower than it's 200 day moving average. When it does if you buy and hold for the next 365 days you will do very well.
This strategy is of the “reversion to the mean” type. When bitcoin is trading below it’s 200 day moving average this is considered unusual and you should expect it to revert back to the usual situation of being above its 200 day average. Intuitively it’s a bit like value investing, where you buy when something is historically cheap since you expect it to become more fairly valued later.
First let’s take the case where you buy bitcoin when it goes below it’s 200 day moving average, and then hold it for 365 days. If during the 365 day holding period it again goes below it’s 200 day moving average, you don’t buy again. Only after the 365 days is up do you look for the next buying opportunity. Lets call this version of the strategy “P1”.
I’m using the bitcoin price series BCHAIN/MKPRU from Quandl which contain’s the daily close price going back to 2010. Here’s a list of the trades you would have made. The last trade has not yet finished it’s 365 day holding period so for now I’m using the close price on 9th Jul to score it. In 200 or so days I will need to come back and update this.
Here’s a chart for 2011 showing the 200 day moving average and the first buy ocurring during Sep 2011.
It’s interesting to see the 2011 bubble and crash in the context of the 2017/2018 bubble and crash. This prompted me to do a quick side by side comparison, shown on the chart below. 2011 is shown by the blue line, and 2017/2018 by the white line. Both price lines cover a period of 1 year.
It’s impossible to say whether the 2017/2018 bear market is over, but the comparison does clearly show that the type of rise and fall we saw in 2017/2018 has happened before and is not that unusual.
Finally here’s a summary of the overall results compared to buy and hold
5 buys, 4 sells so far
Arithmetic average return 190.1%
Geometric average return 68.4%
Strategy return for the period 1,253.6%
Buy and Hold return for the period 79,312.7%
So although the arithmetic average of the individual returns at 190% sounds very good, this strategy would have done orders of magnitude worse than buy and hold over the same period (roughly only 1 thousand percent return versus 79 thousand percent return). For the buy and hold comparison I’m assuming you start buying and holding on the same day that the strategy makes it first trade.
Now let’s change the rules so that you buy EVERY time the price crosses under the 200 day MA, even if you are within the holding period for a previous buy. Using these rules there would have been 19 trades in total instead of only 5, listed below. Let’s call this version of the strategy “P2”.
Most of the individual returns look pretty good, but you’ll notice a bunch of the trades made during 2014 did not work out very well. The 365 day holding period was not long enough to get you past the brutal 2014 bear market. Here’s a chart showing what happend during 2014 when the price fluctuated above and below the 200 day moving average a few times leading to 8 different buy points, and the price for these did not recover during their 365 day holding period.
Finally here’s a summary of the results comparing them to buy and hold.
19 buys, 16 sells so far
Arithmetic average return 110.5%
Geometric average return 14.4%
Strategy return for the period 1,179.0%
Buy and Hold return for the period 79,312.7%
The overall results for P2 are worse than for P1, and is again orders of magnitude worse than buy and hold over the same period.
So far we have done the analysis assuming that you started investing in 2010. Let’s now take this a step further and look at a range of different starting dates. The chart below plots the compound annual return for P1 versus buy and hold by starting date. The blue line is buy and hold, the orange line is P1.
As you can see buy is hold is always better no matter what the starting date. One reason for this is that the P1 strategy only holds for 365 days and then waits for the next buying opportunity. So it’s not in the market all the time and misses out on a lot of the price appreciation. Let’s create a 3rd version called P3 that buys when the price goes below the 200 day moving average, and then never sells. So like buy and hold it only makes one trade, but instead of buying now it waits until the next time price is below the 200 day moving average. The chart below compares the compound annual returns for P3 to buy and hold for various starting dates.
As you can see buy and hold is better most of the time, but there are 3 times that P3 would have been better. Mid 2011, pretty much all of 2014, and 2018 so far. The reason is clear, these are the 3 times there has been a very large run up and then crash in the price. So at these particular times if you had waited for price to fall below the 200 day moving average you would have been better off. But the question is, would you have known this at the time.
Putting it all together here are my closing thoughts for part 1:
- Waiting for a break below the 200 day moving average and then holding for 365 days is always worse than buy and hold. The 365 day holding period is too short, and by being out of the market you miss a lot of the price appreciation. For example this strategy would have kept you from buying at the Dec 2017 highs (which is good), BUT it also would have prevented you from participating in the 2017 bull run (which negates the good part and a whole lot more).
- If you are looking for a good time to buy and hold, “right now” is almost always the best answer. The only exceptions to this have been the points just before a large bubble and crash. These are easy to see in hindsight, but hard to identify at the time. If you are wrong you may end up never getting into the market, or missing out on price appreciation that is bigger than any subsequent crash.
- Since at the time of writing (9th Jul 2018) we are currently below the 200 day moving average, there is no difference between buying “right now” or “waiting for a break below the 200 day”. Historically this looks like a good entry point for a buy and hold investor, and in that sense I agree with Dan’s “bitcoin is currently a screaming buy” statement. But if you are only going to hold for 365 days then historically that might not be long enough.
In part 2 I’m going to look at a variety of momentum strategies to see how they fare against buy and hold. Unlike mean reversion strategies, momentum strategies buy when prices are rising, and sell when prices are falling. Intuitively they are like growth investing, where you buy something that might not appear to be cheap today but you think will be worth a lot more in the future. This feels to me like a better fit for bitcoin, which goes up a lot and also down a lot.
I hope you enjoyed this article. If you got any benefit please click the clap button so that others can find it too.
Please note that nothing in this article should be taken as investment advice. Bitcoin is extremely volatile. Before investing please do your own research. Never buy more crypto than you can afford to lose.