This paper explores the breakout trading system of Bitcoin.
Not only "insist"
I want to talk to you about this kind of trade because even if simply buying and holding, or as some would say, more simply "holding" cryptocurrencies, still pays a lot (see the last rally in 2021), there are still other ways, other strategies, that if set up correctly, can yield the same returns. These strategies can also include the more trivial risk of "buy and forget" operations, which may somehow expose our accounts to greater volatility than short-term long/short operations.
But what are the main characteristics of cryptocurrency markets? Are they by nature more inclined to follow well-defined trends or to reverse at precise price levels? This is the first question that needs to be answered, because in order to have an advantage, an "edge" in the market, it is necessary to know what are the characteristics of the underlying securities you will be trading.
Bitcoin's "trend following" strategy
I researched the most traded cryptocurrency: Bitcoin. I tested a simple "trend following" strategy that buys and sells at precise levels, i.e. the highs and lows of the previous day. The idea is to use the trend to your advantage. If the market rises and breaks above the previous day's high, then I will enter a long position. If the market drops to the lower trigger point, which is the previous day's low, we will go short.
Figure 1. Pattern configuration of the daily chart.
Figure 1 shows an example of the pattern discussed, where we see our strategy enter when the levels we discussed before are broken. In the K-line chart, the daily bars are shown, using a size of $100,000 per trade. This is for standardized backtesting as bitcoin has risen a lot in recent years, and then for consistency of results we will use a very large fixed currency size so that we can scale the number of contracts without any problem.
This strategy tends to gain at the moment when the market breaks through sensitive levels and continues in that direction in the following days.
So I tried to test this idea in the past to see what kind of returns this very simple strategy would generate.
Figure 2. Upward profit curve for trend following strategy.
Well, we can see in the image in Figure 2 that the upward profit curve generated from 2015 (the year we started our study) to the present will generate substantial profits. In general, the curve seems to be very stable both in the initial moments of the backtest and in the final phase, however, we see a very small decay in performance.
Figure 3. Bitcoin buy-and-hold K-line chart.
Obviously, the profits generated by simply buying and holding bitcoin (Figure 3) would be much higher. But we can also see how automated trend following operations (long and short) progress better in terms of profits compared to simple buy and hold.
Most importantly, the retracements of our strategy are low and numerous, suggesting that the operation may be less painful than a "buy-and-forget" strategy.
There are several factors to consider, but from what emerged in this study, both strategies provided excellent results. One strategy would definitely be safer, but would give up huge profits. On the other hand, it would expose our accounts to unmanageable long-term losses.
Andrea Unger. Italian trader and writer known for being the only four-time world trading champion (2008, 2009, 2010 and 2012). Graduated in Mechanical Engineering from Politecnico di Milano and member of MENSA since 2001, independent trader.
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