What Fundamentals?
In the cryptocurrency space, fundamental analysis is often difficult to complete for the DIY investor. As such, gains are often sought by employing technical analysis. One of the most common and easy to understand signals in technical analysis is the crossing over of moving averages(MA). When a short-term MA breaks through a longer-term MA in an upward direction it is often a bullish signal.
Premise
This article will examine the historical price actions of Bitcoin when a particular signal occurs. Using Coinbase prices for BTC/USD, metrics for the week following a 7-day MA breaking the 14-day MA will be analyzed in an effort to provide insight on the impact this signal should have on your investing strategy.
Bitcoin Over Time
Since 2015 BTC/USD has traded as low as $200 and as high as $19 550. While this astronomical increase would make any investor ecstatic, finding an offering that will increase nearly 100x over 3 years is difficult to say the least. Reliably finding a more modest gain again and again is an attractive alternative to holding such a speculative investment for a long period of time. Technical analysis is one of the most reliable ways to secure this modest gain.
Utilizing technical analysis for investment purposes requires historical analysis of prices first, and then developing a stringent set of rules to follow when making investment decisions. This is the reason computers running algorithms play such an important role in the world of finance today. They make cold, rational decisions based on empirical data.
Rules for BTC/USD
An investor employing the following basic strategy from January 2015 to July 2018 would have had 15 opportunities to enter the market with a reasonable expectation of profit:
- 7-day MA breaks through 14-day MA in upward direction
- Trading volume on day of breakthrough is above 14-day MA
Following these two rules would allow an investor to sell BTC within one week for a >10% gain eight times (53% accuracy), or for >5% gain eleven times (73% accuracy). Utilizing a 5% stop-loss rule in conjunction with a 5% profit-taking rule would lead to a total return of 82.15% (~18.72% annualized).
Bending the Rules
To highlight the importance of following all parameters of a technical signal before making a trade, here are the results of ignoring rule 2. The 7-day MA broke the 14-day MA thirty-two more times, but on trading volume below the 14-day MA. Trading on these weak signals would reduce the prediction accuracy for 10% gains to 32% (a 21 point drop). For 5% gains the accuracy drops to 49%. It is possible to build a profitable strategy with a 73% reliable signal, however it is a losing proposition to trade on a coin-flip. Utilizing the same 5% stop-loss and profit taking margins as above leads to the investor only realizing a total return of 38.9% (~9.86% annualized).
A nearly 10% annualized return is nothing to turn ones nose up at, but if an investor had stuck with their more stringent rules they would have realized a larger profit. This fact reinforces the oft stated advice that more trades often leads to less returns. Develop a stringent set of conditions to trade under, test them and then employ them!
Disclaimer: This article is for information purposes only and should not be construed as investment advice in anyway. Never invest what you are not prepared to lose.