How To Take Profits Before The Next Bitcoin Recession
How long will the current Bitcoin rally continue? When will the next Bitcoin recession be? As a Bitcoin enthusiast I hope it’s a few years out, but the truth is I don’t know. And I don’t intend to forecast. However, I have high confidence that there will be a recession again at some point in the future. Cyclical ups and downs are a reality of economics, and they get magnified further for assets with a large speculative element. There’s plenty of historical evidence that the larger the speculative element, the more extreme the cycle — whether it’s Bitcoin, other crypto, technology stocks, cannabis stocks, take your pick.
The objective of this post is to demonstrate the merits of using a disciplined strategy to gradually build a position in high-return high-risk assets like Bitcoin, and potentially take profits along the way.
Let’s start with a story.
Joe invested a small amount in Bitcoin in early 2016 at a price of around $400. By the end of the year, Bitcoin was over $900. Joe doubled his investment. The price dipped a few times along the way but it always came back stronger than before. So Joe invested even more and saw Bitcoin rise above $2000. A few more dips came but Joe had seen it before. He knew what to do. He invested even more and the price rose above $4000. Doubled again. Then it rose to $6000, then $10,000, and way beyond. Joe continued to hold — probably waiting for a target price where he would sell, or deluded that this party would go on forever.
The problem with peaks is that you only see them in distant hindsight.
Then Bitcoin hit a peak above $19,000 and started crashing. The problem with peaks is that you only see them in distant hindsight — a long time after they have passed. Initially, it looked like yet another dip. Bitcoin fell to $12,000 but rose back to over $17,000 again. This time Joe thought he should lock in profits, but he wouldn’t do it just yet. He would sell as soon as Bitcoin got back to $19,000 again. He had seen this drama before. He knew what to do. But then Bitcoin fell again, and again, and again. Now, Bitcoin was trading in the $3000–4000 range but people were forecasting it could drop further to $1500. So Joe sold it all.
Maybe Joe made some money, maybe he lost some, maybe he lost a lot. In either case, he was glad he was out — he decided the volatility was too much for him and he would stay away from Bitcoin and crypto in the future.
End of story. Or maybe not? Joe’s been watching Bitcoin rise since and wonders whether he should buy again.
What Could Joe Do Differently?
We all know how hard it is to time the market perfectly. A handful manage to do that — more out of luck than skill. Majority of us are left facing the financial and emotional consequences.
Let’s try a different strategy. A strategy that allows us to build a position, and take profits. Can one strategy do both? Yes, and it’s actually rather simple. The strategy will require a shift in perspective though — one has to give up greed, and add discipline to their investing. That’s not a bad deal either, is it? Replacing greed with discipline should have positive emotional consequences too. Make money, and sleep better.
Building a position and taking profits at the same time is rather simple.
Instead of buying and selling at random points, we will target growing our Bitcoin position by a certain dollar amount every month. I use $1000 for illustration but the strategy works with any amount. There are three elements (rules) to this strategy:
- Target — We target growing our Bitcoin position by $1000 every month. So in month 1 our target position is $1000, in month 2 $2000, in month 3 $3000, and so on.
- Buy limit — In any month, if our actual position is below the target, we buy up to $1000 worth of Bitcoin to add to the position.
- Sell limit — If our position is above the target, we sell up to $1000 worth of Bitcoin to reduce the position.
That’s it. Let’s see how the strategy performs from 2016 to 2018 — the same period that Joe went through in the story.
Read the numbers in the table below from left to right.
- The price of Bitcoin at the end of January 2016 is $370. BTC Price in the table below.
- Our Initial BTC Position is zero, both in $, and in units i.e. number of Bitcoin.
- Our target is to grow the Bitcoin position by $1000 every month, so in the first month the Target BTC Position is $1000.
- To meet our target, we spend $1000, and buy 2.7 BTC at the price of $370. Columns BTC Buy/(Sell) in the table.
- As a result of the purchase, our Final BTC Position for January is 2.7 BTC valued at $1000.
- The Final Cash Position is $-1000; negative because we took cash from our pocket to buy BTC.
Our initial BTC position is the 2.7 BTC we bought in January.
- BTC Price rose to $436 in February.
- The 2.7 BTC we bought in January is now worth $1179. Initial BTC Position in table below.
- The Target BTC Position for February is $2000. Remember our target is to grow the Bitcoin position by $1000 every month.
- Since our initial position is valued at $1179, we only need to buy $821 of BTC to meet the target. So we spend $821 and buy 1.88 BTC.
- We end February with the Final BTC Position of 4.48 BTC valued at $2000.
- The Final Cash Position is now $-1821 ($1000 invested in January + $821 invested in February).
Essentially, we spent $1821 and built a 4.58 BTC position valued at $2000 in two months. Remember in this strategy, we are not investing a fixed amount every month; we are targeting a fixed amount of growth in our BTC position instead. Because Bitcoin price rose in February, we had to invest only an additional $821 to meet our target of $2000.
Important: Please go over January and February again if you didn’t follow the steps because we will be repeating the same process every month, and much faster from hereon. You will follow the rest of the post a lot better if you took your time here. Here’s a simplified view of how the numbers flow.
Bitcoin price fell to $416 in March. As a result, our initial position of 4.58 BTC is worth $1906. The target position for March is $3000, so we are $1094 short of our target. Our strategy has a buy limit of $1000 per month though — remember the rules — so we spend $1000 to buy 2.41 BTC. We end the month with a final position of 6.99 BTC worth $2906, and final cash position of $-2821.
Why is there a buy limit? It helps smooth out our purchases. Bitcoin price can rise or fall significantly in any month. Imposing a buy limit ensures we don’t use too much capital in any single month.
Fast Forward to June
April and May were a repeat of the steps we took in February. Then things got interesting. Bitcoin price rose from $529 in May to $670 by the end of June. As a result, our initial position is worth $6334. This is higher than the target position of $6000. So, for the first time, we get to sell. We sell 0.5 BTC for $334 to bring our final BTC position down to target.
Notice our final cash position increases from $-3968 in May to $-3634 in June as a result. This is the first time we had an increase in our cash position.
Come December, Bitcoin price rises to $963, and our initial BTC position of $14,272 is well above the target of $12,000. Just like the buy limit, we also have a sell limit of $1000 per month. So, we sell 1.04 BTC for $1000. We end 2016 with 13.78 BTC worth $13,272 and a cash position of $-6261.
Buy low and sell high. We bought when our BTC position was lower than target, and sold when it was higher than target through the year. Adding up buys and sells for the year gives us insights into how this strategy works:
- We bought 15.32 BTC at an average price of $496. Bitcoin price was higher than that in 8 of the 12 months so we bought at a very good price.
- We sold 1.54 BTC at an average price of $868. Bitcoin price was lower than that in 11 of the 12 months, so we sold at an excellent price.
We bought low and sold high. And not in a small way. Our selling price was 75% higher than the buying price.
We end the year with a BTC position of $13,272 (13.78 BTC), and a cash position of $-6261. Put differently, we spent $6261 to build a BTC position worth $13,272. Due to significant Bitcoin price appreciation, the final position is above the target value even after selling $1000 worth of BTC in December.
We continue to target growing the portfolio by $1000 every month but the ride gets wilder in 2017. Given the impressive Bitcoin price appreciation, we sold in 11 of the 12 months. Moreover, we hit our sell limit of $1000 every month except for January. We only bought once in the month of March.
Note that our cash position turned positive for the first time in September. That means we put our original investment back into our pockets, and kept adding to the positive cash position for the rest of the year. In other words:
We were playing with ‘house money’ starting September.
Buy low and sell high. We bought 0.93 BTC at an average price of $1079, and sold 3.85 BTC for the average price of $2679. Our sell price was 148% higher than the buy price.
Our Bitcoin position grew to $150,394 by the end of the year. That’s over 6 times the target position of $24,000. In addition, the cash position grew to $3041.
A year most Bitcoin and crypto investors would love to forget. How do you think our strategy performed? Let’s take a look.
Remember our Bitcoin position had appreciated to $150,394 (over 6X the target) in 2017. Even though Bitcoin price kept falling throughout 2018, we are so far ahead of the target that we could keep selling 11 of the 12 months, and improving our cash position. The cash position grew to $14,041 by the end of November.
Our Bitcoin position finally fell below the target in December and we bought Bitcoin for the first time in 2018.
Buy Low and Sell High. I am a broken record at this point. We bought 0.27 BTC at an average price of $3747, and sold 1.57 BTC for the average price of $7023. Our selling price was higher once again — this time 87% higher than the buying price.
Bitcoin found a bottom in December 2018. Let’s end the month-by-month play here and summarize the results. We close December with a BTC position worth $35,822 and a cash position of $13,041 — that’s a total of $48,862. We already took our initial investment off the table so these are all profits.
Can We Keep More Profits?
Remember the three rules of our strategy:
- Target — target growing our BTC portfolio by $1000 per month
- Buy limit — buy up to $1000 of BTC when our position is below target
- Sell limit — sell up to $1000 when our position is above target
Since our focus is on keeping profits, let’s try a few variations of rule #3 — let’s change the sell limit. What if we sold up to $2000 per month? Or $5000? What if didn’t sell at all?
The table below summarizes the results of different sell limits. Note, rules 1 and 2 — monthly target of $1000 and buy limit of $1000 — are unchanged across all these tests.
Sell limit $0. We don’t sell at all in this test. The negative cash position of $-7240 reflects that we never took any profits. Once we exceeded our target in November 2016, we never had to buy or sell any Bitcoin again. Our total position (BTC + Cash) is $48,277.
Sell limit $2000. We sell up to $2000 every month we are above target. This results in a much stronger cash position of $29,817, and a smaller Bitcoin position. Our total position is $51,839. This turns out to be the best performing strategy over the test period. Because we sold more aggressively, our Bitcoin position falls below target in November 2018 and we start buying again.
Sell limit $5000. With a $5000 sell limit, both our Bitcoin and cash positions are smaller compared to sell limits of $2000 and $,3000. Why is that? We were too aggressive and sold too much Bitcoin too early. The cash position rose rapidly to $39,181 in February 2018, but then we were buying Bitcoin for the rest of the year. This test shows there is a limit to how aggressively we can sell before performance starts deteriorating.
The strategy tested here is my attempt to combine the merits of Dollar Cost Averaging and Value Averaging. I won’t describe DCA and VA here — you will find plenty of material on the internet. My focus is to demonstrate the merits of using a disciplined strategy to gradually build a position in high-return high-risk assets like Bitcoin, and potentially take some profits along the way.
An investor in high growth assets makes decisions in immense uncertainty — the future value of the asset is near impossible to estimate — so my goal was to provide a simple framework to manage a bumpy ride without losing much sleep.
Also, by setting a target, and a buy limit — $1000 in our tests, but it can be any amount — the strategy gives you flexibility to abandon with smaller losses if the returns are not positive. For example, if you applied the same strategy to an asset that went spiraling down, you could stop investing further in any month, take your losses, and look for a different asset to invest in.
Selling not your thing? Not everyone may be interested in trading part of their Bitcoin position for a better night’s sleep. For those focused on HODLing, you might want to take a look at another strategy I discussed in How To Buy Bitcoin At Deep Discounts.
Taking profits puts money in your bank account, and helps you sleep better. In the various sell limits we tested above, the idea is not to find the best performing strategy and adopt it. Past performance is not an indicator of future outcomes. The goal is to understand the trade-off between HODLing and taking profits, and bring better balance to future investment decisions.
Vishal Karir, CFA is Co-Founder and Chief Investment Officer at Huddl — world’s first social financial marketplace. Huddl founders — former BlackRock and Mastercard executives — saw first hand how the current financial environment favors the wealthy. They have committed to expanding opportunities and lowering costs for everyday investors by bringing the best of Wall Street to Main Street.
This post is for educational purposes only and should not be considered as investment advice or a recommendation of any particular asset, strategy or investment product. The author may or may not own or have owned the assets referenced and if such assets are owned, no representation is being made that such assets will continue to be held.