This article explores a breakout trading system on Bitcoin.
Not only “Hold”
I want to talk to you about this kind of trading because even though it is true that the simple buy&hold, or as some call it, more simply “hold” of cryptocurrencies, still pays a lot (see the last rally of 2021) there are also other approaches, other strategies, that if set up correctly can pay just as well. These strategies can also contain what are the risks of a more trivial “buy and forget” type of operation, which could somehow expose our account to greater fluctuations than a short-term long/short operation.
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But what are the predominant characteristics of the cryptocurrency market? Does their nature tend more to follow well-defined trends or to reverse on precise price levels? This is the first question that needs to be answered because, in order to have an advantage, an “edge”, over the market, it is necessary to know what are the peculiarities of the underlying that you are going to trade.
The “trend following” strategy on Bitcoin
I examined the most traded cryptocurrency: Bitcoin. I tested a simple “trend following” strategy that buys and sells on precise levels, namely the high and low of the previous day. The idea is to use trends to your advantage. If the market goes up to break the highs of the previous day then I will enter a long position. If the market goes down to the lower trigger, the low of the previous day, we will go short.
Figure 1 shows an example of the pattern in question, where we see our strategy enter when the levels we were talking about earlier are broken. In the chart, daily bars are displayed, and a size of $100,000 is used for each trade. This is to standardize the backtest, as Bitcoin has risen a lot in recent years and then, in order to have uniformity of results, we will use a very large fixed monetary size that allows scaling the number of contracts without problems.
This strategy will tend to gain in the moments when the market breaks sensitive levels and continue in that direction also in the following days.
So I tried to test this idea on the past, to see what kind of returns this very simple strategy would generate.
Well, we can see from the image in figure 2 that the cumulative profit curve that would have been generated from 2015, the year from which we started our studies, to the present day, would have generated significant profits. In general, the curve seems to be very constant both in the initial moments of the backtest and in the last period, where, however, we see a very small fading of performance.
Clearly, the profits that would have been generated by the simple buy&hold of Bitcoin (Figure 3) would have been much higher. But we can also see how the progression of profits is better with an automatic trend follower operation (both long and short), compared to the simple buy&hold.
Above all, the drawdowns of our strategy are lower, and by a lot, an indication of the fact that the pain generated by this operation could be less than with the “buy and forget” strategy.
There are several factors to take into consideration, but from what emerged in this study, both strategies provide excellent results. One strategy would certainly be safer but would forego large profits. On the other hand, it would expose our account to long drawdowns that are very difficult to manage.
Andrea Unger. Italian trader and author known for being the only four-time World Trading Champion (2008, 2009, 2010, and 2012). Graduated with honors in Mechanical Engineering at Politecnico di Milano, member of MENSA, independent trader since 2001.