A beginner’s guide to crypto trading Part II — Relative Value Trading
Beginning traders can quickly get overwhelmed by the abundance of tricky rules, tactics, and advice coming from across the interwebs.
In this 3-part series, we ask a professional algorithmic trader, Ben Eacrett, for his advice on profitable trading strategies anyone can start using today.
Previously, we talked about the Strategic Asset Allocation technique. If you missed it, read about it in Part I before learning the next strategy.
Strategy #2: Relative Value Trading
Another strategy that can be applied to volatile assets like cryptocurrencies is relative value trading. At its most basic level, this is the embodiment of ‘buy low — sell high’. There are a lot of flavours of relative value trading and tons of articles around.
We’re just going to describe a simple technique:
Choose two assets that you believe are highly correlated (do your research here) and calculate and track the price ratio over time. Charts can be particularly useful in this strategy to help you identify promising trends. Are there common % ranges or bands the price ratio moves in and then reverses?
You can look at % moves, or get as complicated as you want (e.g. by factoring in moving averages as well), but figure out band levels that you like and write them down.
For this example, let’s assume we’ve found a band level of 2%.
Figure out a ‘leg’ amount — this is the % of your position you are going to sell at a time. Lets set this at 25%. Start off with you capital evenly split between the 2 assets (for example 50% in ETH, 50% in LTC).
Every time the price ratio moves by a band level, we sell 1 leg of the asset that outperformed and use the proceeds to buy more of the asset that underperformed.
So, if ETH went up 4% and LTC only went up 2%, we would sell 25% of our ETH and use that to buy more LTC.
If you’ve managed to find a mean-reverting relationship, this technique can help you capture value from the reversions. The way we’ve described it here keeps you fully exposed to cryptocurrency — market neutral approaches are possible, but best left for another day :-)
Stay tuned for Part III of our Trading Series, where we will talk about Hedging.
For better understanding what it takes to be a successful trader, we talked to a professional trader David Vizsolyi. Read our full interview here.
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