Cryptocurrencies

Decentralized cryptographic currencies




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Introduction

History

Resources

Investing

Investing strategy

Investing simulation

Technical analysis

Trading

Trading simulation

Tips from others



Introduction

A cryptocurrency is a peer-to-peer, decentralized, digital currency.

Cryptocurrencies were born to achieve the crucial and immutable goal of decentralization. Decentralization means that there is no central authority to control the cryptocurrency, the circulating supply, to confirm transactions. Any attempt to revert transactions would lead to chaos in the lives of those who own the cryptocurrency, at least if many other transactions have been performed after the transaction to revert. The potential of such chaos is meant to persuade any central authority that reverting transactions would be far more damaging than not reverting them. A digital currency which isn't decentralized in this manner, isn't a cryptocurrency, and it (and by extension, the lives of the people who have it) is at the whims of any central authority.

Cryptocurrencies, unlike traditional assets, are not owned by companies or governments, so while their creators can disappear, the software and the peer-to-peer network can continue to run, and can be maintained by others. Currently, there is some centralization in most cryptocurrencies; some of them have just a few miners, some have most of their consensus nodes owned by their creators, but things will decentralize more in time.

The vast majority of people probably get involved with cryptocurrencies in order to get rich, and believe that they invest money in companies which will bring them profit. While there are a lot of cryptocurrencies that are designed to work like that, the ones designed to be money are created by companies which want to jumpstart a decentralized platform (of protocols and software) in which anyone can participate to influence and strengthen it. The founding companies will, at some point, fade into the background, while the platforms will remain as infrastructure of this civilization.

Some states want to, and will, create their own cryptocurrencies. A state created cryptocurrency is not a cryptocurrency in the practical sense because it's controlled by one entity, the state, so it's in fact digital fiatcurrency owned by the state, not by the people. It's not decentralized currency, it's centralized.

What is the financial industry sector from which cryptocurrencies are part of? You may hear two names: FinTech and DeFi. FinTech means Financial Technologies and represents a fusion between finance and technology (especially online); it makes no separation between centralized and decentralized services. DeFi means Decentralized Finance and represents a fusion between finance and decentralized technology, the kind started by Bitcoin; it excludes centralized services because it sees them as the main path to institutionalized corruption.

Ignore any cryptocurrency whose creators don't make public the source code which runs the cryptocurrency.

For some cryptocurrencies the entire amount of available units is issued before the cryptocurrency is made public, but for some cryptocurrencies the units are created / mined in time (although some can be mined before the cryptocurrency is made public). In both cases, the software which runs the cryptocurrency can be modified by its issuer to issue more cryptocurrency later.

Most cryptocurrencies have a finite supply (= amount of available units), or have a very small inflation of the supply. Such cryptocurrencies can act as a store of value, like gold, meaning that they can preserve or increase their purchasing power over time; this means that in the future you will need to pay an equal or smaller number of units in order to buy the same thing; this is called "deflation of prices".

In contrast, a currency whose circulating supply increases in time, like fiatcurrency, has a decreasing purchasing power over time; this means that in the future you will need to pay a larger number of units in order to buy the same thing; this is called "inflation of prices".

Since the cryptocurrencies with the largest market capitalization have a fixed circulating supply, it means that their prices (relative to fiatcurrency) may increase in time, in the absence of bad news. This means that the value of the cryptocurrencies that you hold today may increase in time. Obviously, there is no guarantee that a specific cryptocurrency will survive for years or decades.

Be very careful when comparing cryptocurrencies by market capitalization. The market capitalization is calculated from the circulating supply because not the entire supply may have been issued. The supply that will be issued in the future will act as inflation, so someone has to buy the incoming supply just to keep the price at the same level.

Since you can usually own and use fractions of a cryptocurrency's units, with many decimals, a high price per unit is not a problem.

In the first half of 2010, Bitcoin was worth less than 1 cent / unit. 7 years later it was worth over 1'000 USD / unit. This means an increase in price of over 100'000 times, so someone who has invested 10 USD in 2010 and kept it until 2017 became a millionaire. This kind of growth will never be achieved again, not even by far. This has happened because Bitcoin was the start of a financial revolution. As the market capitalization of a cryptocurrency raises, its potential percentual growth decreases because the total possible market capitalization is economically limited.

The World Economic Forum predicts that the market capitalization of the entire DeFi industry could reach 8 trillions USD by 2027. The problem is that you don't know which cryptocurrencies will still have value then, nor which of them will grow faster than most of the others.



Quantifying decentralization

The level of decentralization is represented by the degree of difficulty that an organized group encounters in controlling the consensus, that is, the confirmation of transactions. Decentralization is not represented by the number of nodes from a cryptocurrency's network.

In order to quantify the degree of decentralization (D) in a practical way, we need an asymptote that depends on the number of entities that can collude in order to control the consensus. For example, for 1 entity we can have D = 0%, for 2 D = 5%, for 10 D = 50%, for 50 D = 90%, for 100 D = 99%, with the asymptotic limit of 100%.

An asymptote is used because the doubling of a low number of nodes (say from 5 to 10) has a much higher effect on decentralization than the doubling of a high number of nodes (say from 1000 to 2000), because it's much easier to seize control of 5 entities than of 1000.

If a single entity can control the consensus, the currency is not a decentralized cryptocurrency, but a centralized digital currency.

A cryptocurrency always uses a Decentralized Consensus Protocol for reaching consensus. The used technology is called Decentralized Consensus Technology.



History

Bitcoin is the cryptocurrency which has started the entire DeFi industry. However, its Proof of Work consensus algorithm consumes huge amounts of energy, a transaction may need hours to be confirmed, only a handful of transactions can be performed per second, and the payment fees are too large for small transactions.

Alternative cryptocurrencies have emerged without Bitcoin's technical problems. These use other types of consensus algorithms, like Proof of Stake.



Resources

Coin Gecko = Aggregator of prices. Has free historical API.

Nomics = Aggregator of prices. Has API.

Ico Drops = Upcoming ICOs and statistics.

Ico Stats = Statistics for ICOs.

Bitcoin Magazine = News.

Coin Desk = News.

Coin Telegraph = News.

Binance = Exchange.

Binance DEX = Decentralized exchange.

Binance Jersey = Fiatcurrency exchange for Europe.

Kraken = Fiatcurrency exchange for Europe.



Keep most of your money off exchanges, for most of the time!



Investing

Warning: Many people believe that the cryptocurrency markets work like the stock markets. They want to believe that they invest in something that will make them rich. This is not the case. In the case of the cryptocurrencies designed to be money, there is no company in which you can invest. You can invest in software platforms which have no owner, that is, are decentralized. The software platforms have creators and developers, not owners. The creators and the developers can't help you with problems, like companies can do (or are legally obligated to do).

The most fundamental principle of investing, "buy low and sell high", passes through people's minds like a ghost through the real world: with no effect.

The vast majority of people buy high and sell low, that is, they start buying when they see the price raising, and start selling when they see the price dropping, the opposite of what they should do. The greater the raise, the more fiatcurrency they invest. Then, they complain that they are not making or are even losing money, and start searching for that magical recipe (= charts) that's going to quickly make them a lot of money, just like any other betting addict who believes that he's going to beat the "system" with his "method".

When a cryptocurrency's price raises, nobody (charts included) knows whether that trend will continue or the price will decrease, so you have to follow a strategy which increases the potential profit and decreases the potential loss, balancing them, while still betting (rather than knowing) on a rise of the price in the long term.

You must count on a single guarantee: never, ever, never act as if you know what the price will do in the future, be it near or far.

Sadly, most people will continue to ask questions like "Is this a good time to buy?" Why is it sad? Because it's the wrong question to ask. If the answer were "yes", most people would use it as an excuse to invest a lot of money and then blame the person who has answered, for any drop of the price, even though the answer is correct in the context of a long-term investment.

It's also sad because if people ask someone with investing experience whether it's a good time to buy or not, and they are told that nobody can say what the price will do next, they will insist by asking "I understand that nobody can say what the price will do, but what is your opinion?" So, they ask for advice but ignore the actual advice and, since they only accept a "buy" or "don't buy" answer, they are trying to shift the blame for the aftereffect on someone else.

The purpose of a long term investment is to maintain, and possibly grow, the value of the investment over years or even decades.

Some people say that you should invest a lot of money when the price is low. The problem is that you can never know if a price will raise or drop after you start investing, so you have no idea what "low" is (relative to).

The essence of a responsible investment strategy is:

  • Diversify into several cryptocurrencies. You never know what's going to happen to any single one of them.

  • Split your investment budget in small slices and buy often so that you get an average price. Using all the fiatcurrency that you have to make a single cryptocurrency purchase is very risky because you are more likely to buy at a much higher price than the average; that's how greed works.

Invest in several cryptocurrencies because nobody knows which of the current cryptocurrencies will still be around in a few years, or how much will each grow. Diversification lowers the potential losses and lets you profit from the growth of several cryptocurrencies.

How do you decide which cryptocurrency to buy? Look at the cryptocurrency's team, at its business connections with the rest of the world, at what problems it's trying to solve, at how it interacts with other industries, at its potential technical performance, at the geopolitical context. Is the cryptocurrency an internationalized effort? Is the emerging cryptocurrency designed for a market in which an established cryptocurrency would have difficulties to enter? How does it compare to other cryptocurrencies which try to solve the same problems? Can it keep the pace of the competition? Why would it have a market capitalization similar with the top competition? At the latest, once the cryptocurrency's own blockchain starts working (= mainnet start), the source code for running the cryptocurrency must be public.

Many people will not buy when the price decreases because they fear that it will continue to do so. But you have to ask yourself why would the price continue to decrease and not recover in the long term? Really bad news are a reason, fear is not.

Some people compare buying when the price decreases with catching a falling knife. This is correct for speculative markets (like cryptocurrencies) that are in the contraction phase, but otherwise it's just normal market ups and downs. Only some speculative markets survive in the long term, so you have to be selective and make informed choices.

In non-speculative markets, even if you were to buy at the top every time, you could still make a profit, like in this example.

No matter how safe your investment strategy is supposed to be, you have to be prepared for severe recession periods when there will be months or years of prices that are much lower than those at which you have invested. If external circumstances force you to sell cryptocurrency during a recession, before the price recovers, you will have to be able to support the incurred losses. This is why you should never invest more money than what you can afford to lose.

A cryptocurrency with a small market capitalization can grow percentually much more than one with a large market capitalization, but it can also disappear much easier. Never take a buy decision based on the price, on the number of units that you can buy, or on the total circulating number of units; they are irrelevant as indicators for potential growth.

Follow the industry news, but realize that the people with lots of money, the market movers, will find out the rumors and news before the vast majority of people, and will buy or sell before the rest, leaving the others to buy at the top or sell at the bottom. Then, they'll do the opposite (sell or buy) before the others realize what's happening, leaving everyone else trapped at a loss-producing price (if they were to sell then).

Don't waste your time and energy trying to predict, intuit or guess future prices. Money is made with statistical analysis and risk management, not gut feelings. Gut feelings, greed and fear of missing out (price raises) ruin you in this business.

One of the worst mistakes you can make in investing is to believe that you, after a number of successful predictions (which are actually guesses), have an understanding of how the markets move. Nothing and nobody, be they charts, experts or gods, will save you from the huge mistake that will come at some point, and it will come because you believe that you "get it" now. What you don't get is that all patterns work until they don't, and when they don't, the losses will be large enough to wipe most of your profits (because you will hang in there believing that your pattern will save you, that it will work if you just give it a bit of time).

The fact that people know all these things won't help them. When the time to act comes, a fog of feelings will set over their minds, and logic will desert them. People always find justifications about why they should invest a lot in a cryptocurrency whose price is raising. They'll tell themselves that this time will work because they feel it, that luck is on their side, that they're special people to whom bad things don't happen, that this has worked in the past, that they can see the trend, that this time there is good news, that they know that this cryptocurrency is not like the others and has a history of rebounding quicker than the rest, that this cryptocurrency is the next Bitcoin-like revolution, that this time they will score big to compensate for all the losses, and, finally, that they've heard (on the Internet) of people who do this and make a lot of money. The thoughts of a betting addict. And so, they just click their money away.

State regulation is not bad news. Some investors perceive state regulation to be bad, but in fact state regulation brings stability and predictability for big investors and for businesses. It's important to note that state regulation and banning are different things; regulation means the acceptance and the ordering of the business environment, banning means not accepting and forbidding business. When a rumor about impending state regulation (not banning) causes a dramatic drop of the price, as it usually does, treat that as a good opportunity to buy, but keep in mind that you don't know when the drop will stop.

Invest in emergent markets, if the business model seems sound, because the growth potential (in percents) is greater than in mature markets, and once an emergent market becomes mature, the investment value will have grown much more than it could have grown in a mature market.

For example a cryptocurrency with a market capitalization of 1 billion (at investment time) requires 99 more billions in order to grow your investment 100 times, however, a cryptocurrency with a market capitalization of 10 billions requires 990 more billions in order to grow your investment 100 times, and obviously, it's far easier for a cryptocurrency to grow with 99 billions than 990 billions. Of course, a small cryptocurrency is also riskier for investments since it could disappear easier than a large cryptocurrency, so you should invest only a small amount of fiatcurrency in one.

However, it's important to understand that the price doesn't depend on the amount of fiatcurrency which gets into the cryptocurrency, it depends on the direction in which sellers are willing to provide liquidity, and on the direction in which buyers are willing to consume the available liquidity. This is true for any market.

Liquidity is the ability to trade a large volume of cryptocurrency with very little change in its price. Simplistically, it can be calculated as V / (H / L - 1), where V - volume per period, H - period high, L - period low.

A market capitalization of X USD doesn't mean that an amount of X USD has changed hands from trader to trader, in exchange for cryptocurrency, or that if everybody were to sell then they would be able to do so at the current price. It just means that the interest of the traders to provide and consume the available liquidity has driven the price to that level.

Some people say that cryptocurrencies are in a bubble, meaning that they are valued too high and the bubble will pop. Say this is true and the prices of all the cryptocurrencies drop to 10% of what they are now. That's a buying opportunity, but you should be selective. In the absence of a fundamental cause that can bring cryptocurrencies to a 0 valuation, the prices should recover, for some cryptocurrencies, even though it could take years.

The profits and losses, expressed in fiatcurrency, of a cryptocurrency are realized only when the cryptocurrency is sold in exchange for fiatcurrency. Until then, its value is like Schrödinger's cat, in multiple states at the same time. While the cryptocurrency is kept, its price could change dramatically during the next few days, weeks, months or years. This means that you should not despair when your investment's value is lower than originally, nor should you gloat when it's higher than originally.

While a decrease of the price of a cryptocurrency A (that you own) decreases your investment's value, if you believe that the price of a cryptocurrency B will raise before the price of the cryptocurrency A raises, you can move your investment there without a loss. Even if you do sell, if you later buy back at the sell price then it's as if you haven't sold.

In metaphorical terms, if an elevator gets you down a few floors, you can take back up any other elevator, not necessarily the same. Still, you don't know in which direction any elevator goes, so randomly jumping from one to another might in fact bring you all the way down to the ground floor. In fact, you will most likely jump to a cryptocurrency which had a recent price raise, so you think it will continue to raise without limits, but that's a bad moment to jump to it.

If you start feeling like the market is a living organism that reads your mind and always makes large movements against you just before or after you act, it's because it's true. The market doesn't have anything personal against you, it's just that you are part of the vast majority of people who are predictable and are too slow to recognize a good opportunity and act on it on time. And if you recognize a good opportunity but are unprepared to act on it, the result is the same.

What should you do in such moments? Wait for the market to go through a drop-raise cycle. Why wait? Because nobody knows how long it would take for this to happen, so you shouldn't move to another cryptocurrency whose price you think might raise in the meantime.

Many cryptocurrencies, before they start trading on the biggest exchanges (by volume), go through a pump-and-dump scheme. Such a scheme starts with speculators driving the price up by buying as much cryptocurrency as possible. Other people see the significant price raise and also start buying, increasing the price further. Once the cryptocurrency starts trading on a big exchange, the speculators sell as much as possible (starting from the biggest price), before other people realize what happens and start selling as well. Moral of the story: don't invest in a cryptocurrency before it starts trading on a big exchange, unless you can get it near the bottom of its price.

Selling a cryptocurrency limits the potential profit because the price could keep on raising, and if you were to later buy at a higher price, you would lose the difference between the sell and the buy, compared to what would have happened had you not sold.

If you sell, you don't have to sell everything. You could sell only half, and keep the other half invested because the price of the cryptocurrency might raise.

Never do margin / leveraged trading; this is reserved for trading traditional assets, not for investments. The volatility is already high for cryptocurrencies.

Do you need stop-losses? If you invest on the long term, if you are sure that you can endure years of recession without selling cryptocurrency, if the cryptocurrency will still be around in years, so long as the price is going to continue to raise (because the industry grows), stop-losses are not mandatory.

Always use limit orders because these will be executed at the specified price or one which is more profitable for you. This is very important in a market with a limited liquidity, a market in which your orders may need a long time to be executed.



Phases of speculative markets

In a speculative industry where investors expect the price (per unit) to raise in time, a market will go through the following phases:

  • Discovery: Few people know about the market, interest is very low.

  • Expansion / Hype: More and more people find out about the market, and everybody invest more and more money. The price raises a lot.

  • Peak: Interest in the market peaks, the price peaks.

  • Retreat: Some investors exit the market, taking a lot of profit.

  • Contraction / Extinction: The interest in the market starts fading as expectations are not met in the (short) timeframe of the expansion phase. The price decreases a lot.

  • Indifference / Coma: For most markets, the price will remain very low (relative to the peak), or they will even disappear. The speculative period will not return.

  • Accumulation: Some investors (re)enter the market.

  • New entrants: New markets / competitors appear, who benefit from the experience of all the previous markets / competitors. This phase is an opportunity to invest long term because the (long term) business use cases become clearer.

  • Maturity: The industry finds a place in the global economy, if any. Most of the initial markets no longer exist.

An investor who doesn't sell (most part of the investment) before the contraction phase, will likely make no profit (and will possibly lose money). Since it's not possible to know when the maximum price will be, the investor should ladder the sells. For this, when the price raises a number of times since either the first buy or from the last sell that the investor made, he should sell a significant part of the cryptocurrency he still has (at that point). If the market is not speculative, this action will severely limit the market's profitability.



Investing strategy

This article isn't a recommendation to start investing or trading!

Investing money is risky: you might lose all the invested money!

Never invest more money than what you can afford to lose!

Do not borrow money, do not mortgage or sell your house, do not liquidate any life investment you have (like the pension fund), in order to buy cryptocurrency! Do not risk your future for cryptocurrencies!

This strategy is specifically designed for investors who don't make a living from investing and trading, for cryptocurrency markets, markets which are expected to grow over time and have a very high volatility, not for traditional markets (which may require margin / leveraged trading because their volatility is small, which may require a different approach).

This strategy considers that the cryptocurrency prices are expressed in fiatcurrency, prices which in the long term should be raising.

This strategy is just an example that you can build on. All the values specified here have to be adjusted to the real context.

This strategy is the result of simulations of both investing (see Investing simulation) and trading (see Trading simulation).

Summary:

  • Research and invest in several cryptocurrencies.

  • Create a fiatcurrency budget where you put the monthly savings that you want to invest in cryptocurrencies.

  • Every day / month buy cryptocurrency with a fraction of the budget.

Create a pool of several cryptocurrencies that you could invest in. These should be available on the exchanges that you use.

Let MS be your fiatcurrency monthly savings, that is, the fiatcurrency that you save each month, but not more than half of your monthly income (regardless of how large your income is), which you want to invest in cryptocurrencies.

Let IS be the investment slice of fiatcurrency. Calculate IS = MS / 30. MS is divided to 30, the number of days in a month, because you want to have fiatcurrency to invest every day.

If you have large savings that you want to invest in cryptocurrencies, you should split them in several parts and each month add one part to the monthly savings. How many parts you split them into depends on you, but the larger the savings are, the more months it should take to invest all the parts. Don't divide in too many parts, each part should be at least equal with MS.



Daily buying

You should buy small amounts of cryptocurrency often because you never know whether the price will move up or down in the future, so you don't want to lose opportunities, but you also don't want to risk too much fiatcurrency in a single, large purchase.

Once a day, at any time it's convenient for you, buy cryptocurrency using IS fiatcurrency. This method is called cost averaging.

If you can only buy once a month, buy using the entire monthly savings (IS = MS), in the day the monthly savings become available. In the simulation section you can see that buying daily and buying monthly have similar performances (over a long term and many cryptocurrencies).

Regardless of how the prices of cryptocurrencies vary, always buy using the same amount of fiatcurrency. This means that, for example, if the price doubles then you'll be able to buy only half as much cryptocurrency, while if the price halves then you will be able to buy twice as much cryptocurrency.

Avoid buying during days with extreme volatility (compared to most days).



Buying the dip

While nobody can know whether the price will go up or down, no matter the timeframe, there are markets where it is believed that the price of assets will raise in the (very) long term because those industries will grow in time, and since the supply of the assets remains fixed, the price will also rise. In such markets, "buying the dip" is a good investment technique.

Buying during price dips decreases the possibility of using your entire investment budget to buy at what might be the highest price, but nothing protects your investment if the price trends toward 0.

Regularly evaluate if you can buy a cryptocurrency from the pool, which has a significant discount relative to its recent high (or to your last buy).

Let P be the current price of a cryptocurrency.

Let H be the highest price of the cryptocurrency, from the recent past.

When P is below H with a significant percentage (from H), buy the cryptocurrency. This technique is called buying the dip.

If you want to be sure that you don't miss the buying opportunities created by price dips, set up notifications, via mail or SMS, for the desired prices. Do not set buy orders in advance because other investors can see all the existing orders.

Over a long term and many cryptocurrencies, dip buying has a similar or lower performance compared to daily buying because most significant dips last a long time, time during which you can invest a similarly large amount of fiatcurrency using daily averaging. On top of this, it's very sensitive to the chosen parameters. This means that it's a useful technique only if: it's done manually (to be aware of real life events), it's done at big support levels (not at fixed percentage drops), a lot fiatcurrency is invested (compared to the monthly savings, which increases the risk dramatically), and the dip is large (for example 50%).



Ladder buying

You can extend the dip buying technique by buying even lower dips.

Let BRP be the buy reference price, which is the price of the first buy you've made of a cryptocurrency.

Let BRD be the rung divider. BRD could be 2. The smaller this is, the more it can replace daily / monthly buying, since buys would be made more often.

Create a ladder of prices, where the first is equal with BRP, and every next rung is equal with the previous rung divided by BRD. Each rung has a lower price than the previous one.

When the price of a cryptocurrency drops under the rung which is below the one when the last buy was made, buy that cryptocurrency again.

If you want to maximize the profit relative to the invested budget, the budget slice for each buy has to be proportional with the price drop from BRP. However, this reduces the absolute profit because the invested budget is smaller.



Ladder selling

In a speculative market, an investor who doesn't sell (most part of the investment) before the contraction phase, will likely make no profit (and will possibly lose money).

Since it's not possible to know when the maximum price will be, the investor should ladder the sells.

Let SRM be the sell rung multiplier. SRM could be 10.

Let SRMD be the sell rung multiplier dampener. If this is 1, it doesn't matter. SRMD could be 2.

Create a ladder of prices, where the first rung is equal with BRP multiplied with the sell rung multiplier (SRM). For every next rung, recalculate SRM = SRM / SRMD, basically reducing it progressively at every rung. Every next rung is equal with the previous rung multiplied with SRM. Each rung has a higher price than the previous one.

Let SC% be the sell cryptocurrency percentage to sell at every rung. SC% could be 10%.

When the price of a cryptocurrency raises above the rung which is above the one when the last sell was made, sell SC% that cryptocurrency again.

SRMD exists because as the market capitalization of a cryptocurrency raises, it becomes more and more difficult to raise with the same ratio, so selling should be done more often.

For protecting against markets that drop dramatically from the BRP, for example over 10 times, the next sell rung price should be the minimum between the existing next sell rung price and the current price multiplied with the sell trail multiplier (STM). STM must be greater than SRM, for example 100.

If the market is not speculative, selling may severely limit the market's profitability.



Dip buying calculation sample

Here is a simple example of why it's efficient to buy dips, while still betting that the price will recover, at least in part.

Let's say that cryptocurrency CC has a price of 10 USD. You use 500 USD to buy 50 CC.

The price drops to 1 USD, and you use 50 USD to buy again 50 CC. Now you have 100 CC for a total investment of 550 USD.

At this price, the value of your CC is 1 USD * 100 CC = 100 USD, so the current value of your investment is down to 100 USD / 550 USD = 18% from the total investment.

If the price goes to 0, you have lost 550 USD.

If the price increases to 5.5 USD, the value of your CC is 5.5 USD * 100 CC = 550 USD, so you've recovered your entire investment, even though the price is a lot lower than the original 10 USD.

If the price increases to 10 USD, the value of your CC is 10 USD * 100 CC = 1000 USD, so you have a profit of 450 USD, even though the price is the original 10 USD.



Investing simulation

Here's an industry-wide statistical analysis which allows an evaluation of the performance of various investment techniques. More investment techniques (than those presented here) were simulated.

For those not interested in the details, the conclusion of the (investing and trading) simulations is that you should spend your time researching money and risk management, cryptocurrencies, industry trends, market behavior, and you should balance your investment strategy with monthly buying (see BM) and ladder buying and selling (for new cryptocurrencies, see LBS). Skip charting and predictions.

The simulation software loads the historical prices for all the cryptocurrencies from the current top 400 by market capitalization. There is an observational bias (specifically a survivor bias): cryptocurrencies that were at some point in the current top 400 but have vanished later, are not included, so they don't affect the result.

Multiple scenarios were created, by applying various filters. The diversity of the scenarios is meant to reduce curve fitting due to a specific market behavior during a specific time frame.

Some scenarios show only some cryptocurrencies that were hyped when they appeared. This was done to show the difference between blind investing, and investing in the hyped cryptocurrencies.

The historical data is validated like this:

  • Sometimes, the data provided by the data service contains abnormal information for the first few days of trading. The "First days to ignore" setting specifies how many days to skip during calculations, from the beginning of the period.

  • The ratio between the average prices and between the market capitalizations from consecutive days must be no more than 30 and no less than 1 / 30. Switching to / from 0 is considered valid.

  • If a day contains invalid data, the data from the previous valid day is used instead.

All dates are formatted "Year-Month-Day".

All averages that directly use prices are harmonic. A harmonic average gives the accurate average price when purchasing cryptocurrency with the same amount of fiatcurrency, every time. An arithmetic average gives the accurate average price when them same amount of cryptocurrency is purchased every time, something which is not sustainable. Harmonic averages are better at showing parabolic price raises, because they raise very little during short time frames.

"A" is a harmonic average price, at the specified moment, for a number of previous days which is set by the "A period" setting. "A" is calculated only if a market has enough days (previous to the moments of H and C) to cover "A period", unless the "Unfilled A period" setting is ticked. If "A period" is 0 then all the available days are used to compute the average, not just a fixed number of days.

If the "MC instead prices" setting is ticked, all calculations are performed with the market capitalization instead of prices. This is because the circulating supply (which is part of the market capitalization) can vary wildly for some cryptocurrencies, even in a short time frame.

Column legend:

  • The first column contains the listing position, regardless of sorting.

  • The second column contains: the name (and symbol) of the cryptocurrency.

  • Days = The number of days that are available for calculations.

  • O date = The date from which the market data starts (given the exchange's maximum supplied data and the date filter).

  • H date = The date of H.

  • O = The open price (from the first candle) for the market.

  • BRP = The buy reference price at which the first buy is made. In order to simulate as well as possible the time when investments can be made in each cryptocurrency, by default it's presumed that BRP is the average price of the day when the market capitalization is at least 1 million USD and the daily volume is at least 100'000 USD.

  • LbH = The lowest price between the moments of O and H. LbH can never be during the same day as H.

  • H = The highest price for the market.

  • LaH = The lowest price between the moments of H and C. LaH can never be during the same day as H.

  • C = The close price (from the last candle) for the market.

  • MC (O) = The market capitalization, at the moment of O.

  • MC (BRP) = The market capitalization, at the moment of BRP.

  • MC (H) = The market capitalization, at the moment of H.

  • MC (C) = The market capitalization, at the moment of C.

  • V (O) = The volume at the moment of O.

  • V (BRP) = The volume at the moment of BRP.

  • V (H) = The volume at the moment of H.

  • V (C) = The volume at the moment of C.

  • BRP dip = BRP divided to the lowest price after BRP. This shows how many times the price has dropped after BRP, so you can see how cheap you could have bought that cryptocurrency.

  • BRP raise = The highest price after BRP, divided to BRP. This shows how many times the price has risen after BRP, so you can see how much profit you could have made with that cryptocurrency.

  • V/VA (H) = The volume divided by the arithmetic average of the volume, at the moment of H, for the previous "A period" days.

  • V/VA (C) = The volume divided by the arithmetic average of the volume, at the moment of C, for the previous "A period" days.

  • V/MC (H) = The arithmetic average of the volume divided by the average of the market capitalization, at the moment of H, for the previous "A period" days. In theory this is indicative of the real world usage of the cryptocurrency (at the moment of H), but both the volume and the market capitalization are too easy to manipulate.

  • V/MC (C) = The arithmetic average of the volume divided by the average of the market capitalization, at the moment of C, for the previous "A period" days. In theory this is indicative of the real world usage of the cryptocurrency (at the moment of C), but both the volume and the market capitalization are too easy to manipulate.

  • PAD = The price-to-average deviation, averaged for the entire period. This is calculated like the standard deviation, but the moving average is harmonic (not arithmetic) with a period equal with the value from the "A period" setting. The moving average is calculated only for the days that have enough previous days to cover "A period". The outer average is arithmetic and is calculated only if there are at least "PAD outer A min days" days to average.

  • BaH (H) = Investment technique performance, at the moment of H, for buy-and-hold. Buy a single time at the start of the period, and hold until the end of the period.

  • BD (H) = Investment technique performance, at the moment of H, for buy daily. Buy the daily average, using IS fiatcurrency. Since it's not possible to make a precise estimate, it's presumed that you're buying at the daily average price of (O + H + L + C) / 4.

  • BM (H) = Investment technique performance, at the moment of H, for buy monthly. Buy once a month using the entire monthly savings (IS = MS), in the day the monthly savings become available. For BM, if the day when the monthly savings become available varies (using the value from the "Day in month when MS" setting), the performance varies about ±7% (from the middle between the minimum and maximum).

  • LBS (H) = Investment technique performance, at the moment of H, for ladder buying and selling. The buy at each rung is made with the same budget as the buy made at the BRP, which is equal with MS. The sell at each rung is made 50% of the available cryptocurrency.

  • BaH (C) = Investment technique performance, at the moment of C, for buy-and-hold. This is equal with C / O.

  • BD (C) = Investment technique performance, at the moment of C, for buy daily.

  • BM (C) = Investment technique performance, at the moment of C, for buy monthly.

  • LBS (C) = Investment technique performance, at the moment of C, for ladder buy and sell.

Header line legend:

  • The header line contains averages for the listed cryptocurrencies (so, after the filters are applied). The following columns contain totals, not averages: #, MC (XXX) and V (XXX).

  • All averages are calculated with a median + arithmetic average. A certain number of outlier values on each end of the range (lowest and highest) is excluded from the average; this is set by the "Total A bottom outliers" and "Total A top outliers" settings. This is required because some values could be exceptionally high / low, which is not representative for industry-wide statistics. This makes it possible to see how the lowest or highest performers behave, answering questions like "What's the average performance of the top 20% least / most performant markets?"

  • The performance averages (BaH, BD, BM, LBS) show the realized profit per unit of invested budget (= the total realized profit for all markets divided to the total invested budget for all markets); if the "Absolute profit" setting is ticked then they show the total realized profit for all markets.

  • The markets are sorted by the orange column. Sorting is descending, except for the following columns: Name and PAD.

The monthly savings are added to the budget in the day of the month specified in the "Day in month when MS" setting, starting with the occurrence before the day of the BRP, so it's presumed that fiatcurrency is available at any time to invest.

Each investment technique performance can show either the absolute or the relative profit. If the "Absolute profit" setting is ticked then each value shows the realized profit (in units of invested budget), else it shows the realized profit per unit of invested budget (= the realized profit divided to the invested budget); the second value is the invested budget; if you multiply the two values, you obtain the realized profit. Each unit of the invested budget represents 1 monthly savings. The budget slice used for each buy made by BaH and LBS is 1 monthly savings. This let's you see that if the absolute performance of LBS is, for example, half of the performance of BM, by doubling the budget slice used for LBS, you can achieve the same absolute profit as BM.

Due to various circumstances, not all the budget allocated for investing may be invested, although the remainder is tiny. The performance calculations use only the invested budget, not the allocated one, so the performance indicates what could have happened to the invested (not allocated) fiatcurrency.

The distinction between the allocated and invested budgets could remain a footnote if it weren't one of the most important aspects of investing (and trading). There are investment techniques (like BaH and LBS) that can produce huge returns (relative to the invested budget), but only work in very specific conditions, conditions which (due to risk management and money availability) allow you to invest only small amounts of money at a time. This means that such a technique might produce an absolute profit similar to or lower than that of a simple technique (like BD and BM) that produces a smaller relative profit, but allows to invest a much higher budget (in time).

The distinction between the relative and absolute profits is critical for LBS when you want to invest in very few cryptocurrencies. This is because it's possible that their prices don't drop after your first buy in each, which means that you would be unable to increase the invested budget. In such a case it's recommended to combine LBS with BM (so use BM and also use the ladder buys from LBS, with a fixed budget, not proportional with the price drop from BRP). This allows the accumulation of as much cryptocurrency as possible, in the early days of a cryptocurrency, without taking the risks associated with investing all the money in a single purchase.

All investment techniques do ladder selling, relative to BRP, if the "Enable selling" setting is ticked. Only a part of the available cryptocurrency is sold at each rung.

If the "Don't buy after first sell" setting is ticked, the profit (both relative and absolute) is slightly improved, except for price peaks, where the situation is reversed; "slightly" means somewhere between 3% (for BM) and 10% (for BD).

The smaller BRD (not BRP) is, the smaller the relative profit is, but then bigger the absolute profit is. For example, for BRD 1.1, the absolute profit for LBS is by far the greatest of all (about 50% more than the next one, for about 20% more invested budget).

Each investment technique, each parameter, has strengths and weaknesses. None will perform best in all scenarios. In summary:

  • BaH and LBS are more profitable in relative terms than BD and BM, but their use is limited because they require the ability to invest as close as possible to a market's beginning and, due to risk management, the invested budget is limited (compared to a budget which is invested over a long time), which means that the potential profit, in absolute terms, is also limited.

  • Any technique can be devastating in particular cases, which is why they must be combined with diversification.

  • Generally, the relative profit of LBS is slightly higher than that of BaH, while in the absolute profit is significantly higher than that of BaH.

  • For LBS, if each buy is made with a budget which is proportional with the price dip, the relative profit is significantly higher (compared to when buys are made with the same budget), but the absolute profit is significantly smaller.

  • Generally, BD and BM produce a greater absolute profit than BaH and LBS, because a much higher budget is invested in time; same for losses.

  • Laddering the sells is good during downtrends and over periods of great volatility, but significantly reduces the profits during uptrends.

  • The profitability of "Don't buy after first sell" depends on the scenario, that is, can be either a bit better or worse either ticked or unticked.

The trend of the markets can be seen from the performance of BaH: well under 0 represents a downtrend, well over 0 represents an uptrend.

If you are looking for the least riskiest, regardless of the time frame, you have to look for the most average in all scenarios, the BD and BM. As a side note, BD and BM have a better performance than the EMAs crossover; for trading it's a different story because traders want to get out of a market as quick as possible (which the EMAs crossover makes possible).

For strongly ascending markets, between the dates 2017-01-15 and 2018-01-15, the performance is here. You can see that BaH has the highest profit at 93 * MS (so the markets have risen dramatically), BD is at 48 * MS, BM at 62 * MS, and LBS at 100 * MS. For the top 400, you can see here that BaH is at 35 * MS, BD at 20 * MS, BM at 29 * MS, and LBS at 43 * MS.

For partially ascending markets, between the dates 2017-01-15 and 2019-11-03, the performance is here. You can see that BaH has the best performance at 56 * MS (so the markets have risen dramatically), BD is at 19 * MS, BM at 25 * MS, and LBS at 42 * MS. For the top 400, you can see here that BaH is at 9.8 * MS, BD at 1.3 * MS, BM at 2.6 * MS, and LBS at 5.1 * MS.

For strongly descending markets, between the dates 2018-01-15 and 2019-11-03, the performance is here. You can see that BaH has the worst performance at -0.68 * MS, BD is at -0.06 * MS, BM at -0.15 * MS, and LBS at -0.32 * MS. For the top 400, you can see here that BaH is at -0.5 * MS, BD at -0.12 * MS, BM at -0.18 * MS, and LBS at -0.37 * MS.

Generally speaking, the more markets are included in the simulation, the lower the performance gets. For example, the performance for the selected hyped cryptocurrencies is greater than the performance of the cryptocurrencies from the top 100, which is greater than the performance of the cryptocurrencies from the top 400. This means that, generally, it does pay off to be selective, but keep in mind that many unicorns raise up from the lower positions.

For cost averaging, aside from BD and BM, other buying triggers (that are not displayed) produce a similar, yet mostly lower, performance, and are more sensitive to the chosen parameters. The ones that do barely improve the performance are not worth the complexity for manual investing, and obviously have no guarantee for the future performance. For example, to improve the performance just slightly on a very long term, look at the chart every day and if you see a downtrend for the previous 10 days, avoid buying; if you still have fiatcurrency (from the monthly savings) in the day before the next monthly savings become available, buy.

If you're wondering if for BD and BM it would be better to buy with more than the normal slice (IS) when the price is under an EMA (slow or fast), and buy with less when the price is above an EMA, simulations show that it's not better, it simply averages out. Even worse, during long uptrends you lose a lot of profit because the price is always above the EMA, be it slow or fast, so you invest less. During long downtrends you quickly run out of money to invest (since each day you invest more than 1 / 30 from the monthly savings), which means that you buy at higher prices than if you were to buy toward the end of the investment month.

The data is retrieved from CoinGecko and has some specifics: it provides an average price per day, rather than OHLC, so you may see significant differences from other data sources, especially regarding the highest price.



Technical analysis

What's being argued here is not whether someone can or can't make a profit using technical analysis, but whether technical analysis predicts anything. If a trading algorithm makes a profit smaller than what could be made by simply holding the original investment in the cryptocurrency, then it's not a predictive algorithm, it's a risk management algorithm (like many others).

Traders always try to make a profit before others can, so trading is a giant poker game. This is why the future can't be predicted by the past.

Technical analysis can only describe what has happened in the past. When it's trying to predict the future, technical analysis is like astrology.

If technical analysis tells you that in the future the market will go up... unless it goes down, it's useless. To be useful, it must tell you only one of the following signals: wait, buy, or sell.

The price, the volume, the order book, the indicators, the overlays, they all show what was and what is, but never, ever, can they show what will be.

Technical analysis overfits the patterns to the data, so it works for the past because the analyst changes the described pattern to fit the analyzed data for the time frame.

Believing that technical analysis predicts the future of a market is like driving on a road and believing that the road predicts where you are going since it always surrounds your car. In both cases, you are the one who is overfitting the patterns to the data. Just like you are the one following the road, and not the other way around, also a technical indicator is following the market, and not the other way around. Just like you can't know how the road will turn next (just because you saw how it turned so far), you also can't know how the market will turn next (just because you saw how it turned so far).

Some people say "But look at how the price moves around the average, at how it bounces when it touches the Bollinger band, it obvious that TA works!" The average shows you what has happened, not what will happen; it contains only past information. In fact, the average follows the price, not the other way around. Same for the Bollinger band. That's why the price is sometimes way off from the average, or outside the Bollinger band: because the TA indicators will follow the price at a later time, not the other way around; they can't predict the future, they only describe what has been (on average).

Some people say that TA works because everybody follows the same signals. If the majority of traders were to follow the same signals, for example to buy, then the price would move up because if someone buys then someone must sell. If not enough traders sell, the price would move against the majority (= up), trying to find the requested liquidity.

"Against the majority" means exactly that, not against the first movers. If the majority of traders buy, the price moves up and you might think that's a good thing (= not against the majority). However, the price would move most for the first buyers, and not at all for the last buyers. In the meantime, the successful traders would start selling, which means that the price starts moving down (because there are no more buyers). This means that the first movers make most money, while the last movers lose most money.

Not convinced? Then ask yourself, who makes money from trading? The majority of traders who follow the same signals, or the few experienced traders who are the first in what they do and take the position opposite to the majority? Also ask yourself, who is rich, the majority or the few? If the majority of people are not rich then why would you do the things that the majority does, why would you not change, why would you avoid doing what is needed to become at least as knowledgeable and experienced as the rich people? Why not? The answer is simple: because you are part the majority of people. Change!

Why does TA appears to work sometimes? Because the price happens to move in the expected direction (for example, up for long positions), because the investor buys low and sells high, and because the investor uses tools which increase the probability to make profit. These tools are: money and risk management, industry-wide statistical comparisons, gathering and interpreting the rumors and news (even using machine learning), understanding the mass behavior of investors, and even trading algorithm simulations which show what doesn't work.

There are lots of recognizable patterns on charts. The problem is that all these patterns are transformed continuously, that is, they are scaled, sheared and rotated in unpredictable ways. Recognizing them afterwards is utterly useless, and in fact it's dangerous because it makes you think that recognizing them is useful in making a profit. It's like seeing shapes in coffee grounds; sure, you can see shapes in coffee grounds, but they have absolutely no effect on the future.

For example, in technical analysis there is a pattern called "pole and pennant" which is supposed to predict that a significant change in price will follow. This pattern looks like a triangle with the base on the left side and a vertex on the right side. This triangle is the result of mass behavior, that is, it's the effect of a cause. A significant change in price does follow, but not because of a geometric shape on a chart.

The reason why this triangle appears on the chart is that, firstly, the price moves in cycles, meaning that significant changes (up or down) are followed by small changes (called "consolidation"), then followed by significant changes, and so on. Secondly, in a period of consolidation cryptocurrency is bought at continuously increasing prices (= with an upward slope) and sold at continuously decreasing prices (= with a downward slope), with the buys and sells centered around the middle of the triangle. Once the price flatlines and the triangle gets its right-side vertex, meaning that profit can no longer be made with small price changes, a significant price change follows (possibly only after a while). The direction of this change is determined by external causes, not by geometric shapes, and this direction is the only thing that matters when trying to make a profit.



Trading

Trading can increase the potential profits (compared to investing), but at the same time increases the potential risks.

Trading is like a giant game of poker, that is, the participants try to make a profit in a zero-sum game. There is a slow increase of the total value of the markets which have a limited number of shares, because the economy increases in time, just not enough to matter for trading, only for very long term investing.

A trader must be very determined to succeed. You might think that you are too, but you are competing against the world's best traders, you are competing against organizations which get the news before they become public, and which simulate and execute their trading with farms of computers. How good are your chances? Some informal research says that, in the traditional markets, 1 in 30 (male) professional traders can make a profit that will keep them in the business for many years. Some formal research says a similar thing. That's 1 in 30 people who try trading professionally, not of all people, not of home traders! So maybe stick to investing? Still, trading can easily turn you into a millionaire... if you start out as a billionaire.

In the same time frame, it's most likely that you would make more fiatcurrency by simply holding your original investment in the cryptocurrency. Plus, you would not have to go through the effort and stress that trading requires, and you would not risk losing everything.

Trading requires the trader to "buy low and sell high". Don't interpret this as "buy the bottom, sell the top"; you don't need to know where either the bottom or the top are.

Beginners ask themselves what this means in practice, they ask how they can possibly know when the "market turns", that is, when the price stops decreasing and starts increasing. The answer is simple: you don't know, nobody knows. This is the wrong question to ask, a dangerous question which will keep you stuck in the belief that you have to know for sure.

The correct question is: how do you make a profit? Profit is not made with predictions since there is absolutely no way to predict the future price, it's made with statistical analysis and risk management. To make a profit you don't need to know the exact movements of the price, you need the probability to be in your favor. The winning trades must bring more profit than the losing trades bring losses, so that they can cover the stop-losses, the exchange's fees, and the price slippage (because the available liquidity might not cover your orders, in their entirety, at precise prices).

You can use any algorithm which signals you to buy and sell, but, in order to make a significant, sustainable profit, the algorithm must be simulated with past data, and then used for the future in the hope that the future will be similar enough, even though not identical.

If you buy low and sell high, the amount of fiatcurrency you have is multiplied (compared to the original) with the sell price divided by the buy price.

Your ability to trade (and therefore increase your budget) is limited by the liquidity which is available during the execution of the orders, so don't image that you can trade millions with the same ease as thousands. The liquidity can be inferred (with good precision) from the volume.

If you want to make an order to buy / sell a significant percentage from the (short-term) traded volume, your order will get entirely filled only if you use a limit order which allows the price to move against you, beyond what you intended to use as a price. This allows more liquidity to become available for your order. This is called price slippage and eats a part of your potential profit. This means that beyond a certain amount of currency, the trading budget must be split among several orders and executed at different times, and even for different cryptocurrencies; even so, there still are limits.

A trade's closing price can be a combination of:

  • A closing price that you get from your algorithm. For example, the crossing of a fast moving average over a slow moving average.

  • A profitable sell price which is, for example, calculated as a percentage from the buy price, above it.

  • An unprofitable hard stop-loss price which is, for example, calculated as a percentage from the buy price, below it.

  • A trailing stop-loss price which is continuously calculated, for example, as a percentage from the highest price which has occurred after the buy order was executed; this means that the trailing stop price keeps raising together with the highest price which has occurred since the buy order. If the price falls back down to the trailing stop price, a sell order is executed. Trailling stop-losses are a better signal to close positions than EMAs crossovers are.

Making a profit from trading depends on the price going both down and up. It is however irrelevant when this happens, it's irrelevant if the price is trending up or down, it only matters if you find opportunities when you can buy low and sell high, no matter what the price is.

Here is an example. Let's say that you have an amount of fiatcurrency F1. You wait for the price to drop to half from the maximum price from the past 2 months. Then you buy. Then you wait for the price to double, and sell. At this point you have amount of fiatcurrency F2 = 2 * F1. After 3 such trades you have F4 = 8 * F1.

How do you chose your trading algorithm? You simulate each potential algorithm, with various parameters, on the past prices for the chosen cryptocurrency, whether manually or in software. The more detailed the simulation is, the smaller the risk can be. You only need to know the open, high, low and close prices of each candle. Also, the volume is useful to get an idea about how much you can trade during a candle.

It's best to simulate in software because once you implement your algorithm, you can instantly simulate it over any period of time, with any set of parameters, for any cryptocurrency. You can also continuously simulate the algorithm using new data, to see if the parameters have to be changed because the market has changed its structure. You can even implement an optimizer which finds the most profitable simulation; do keep in mind that you have to strive for repeatability, not profitability.

You must simulate your trading algorithm! There is absolutely no way around this. Slight variations can mean the difference between ruin and richness, and an algorithm which works for one cryptocurrency might not work for another. Any algorithm that works in simulations is a potentially profitable way to trade, but a simulation can only give you the optimal algorithm for the past. A simulation's result is no indication of what the used algorithm will do in the future.

If you find an algorithm which shows an enormous potential profit, you should not gloat. You have just overfitted the solution / curve to the data, so the algorithm would not yield a similar profit on other time frames. You could, in theory, find an equation which describes every ebb and flow of the price, for a given time frame in the past, equation which shows an astronomic potential profit, but will the price movements be exactly repeated in the future? Absolutely not, so this equation will either bring zero profit in the future, or ruin you. The best algorithm is not the one which shows the highest potential profit, but the one with the most repeatable pattern (which you can't know in advance).

Once you simulate the algorithm on a specific time frame and get a good profit, simulate it on several other time frames which are close to the initial time frame; they have to be close because it's presumed that the market has the same characteristics for nearby time frames, but could have other characteristics for time frames which are farther in time.

A simple algorithm will better fit across multiple very different types of price movement, even though the profit will be modest. There will always be price drops followed by price raises, but the exact same ebbs and flows of the price will never be repeated. So, strive for repeatability, not profitability.

The shorter the trading time frame is, meaning the time between the opening and closing of an order, the faster and more reliable the Internet connection has to be. Retail traders should not try trading on time frames shorter than 15 minutes because they would be unable to compete with trading farms, and the resulting price slippage could lead to ruin.

Price movements are trend-based, not random. You might think that this is a good thing, that you need trends to make a profit, but random movements actually create more trading opportunities, and therefore increase the potential profits compared to the case of trend-based movements.

Some people say that since the price movements are not random, it's possible to make a profit from them. Poker is also not random, it's based on the ability to read other people, yet when playing against the best players in the world the majority of people will lose everything. The same happens in trading.

While artificial intelligence can be used to find profitable solutions which elude humans, it normally works when there is a target to find, that is, when it's possible to iteratively improve on potential solutions until an optimum solution is found. However, trading is a moving target, a target which tries to evade whoever or whatever attempts to catch it, a target which plays poker with its participants. Artificial intelligence works best when it has access to and can interpret news before they are released to the public.

Stop-losses are extremely expensive and can quickly decrease your budget to a fraction of the original one. For example, 3 stop-losses of 20% will bring your budget down to 50% from the original one; it's presumed that margin / leveraged trading isn't used.

Do you need stop-losses? If you were to do margin / leveraged trading, the stop-losses would be automatic. If you trade on short time frames, you need them; without them, you would periodically end up unable to trade for a long time, and unable to sell (for a profit) because the sell price would be well below the buy price.

To decrease the probability of losing your entire budget in stop-losses, you have to split your budget in several parts and only risk a single part in a trade, at any given time. For example, split your trading budget in 3 parts. If you have a 20% stop-loss (because the volatility is high) and you use no margin / leveraged, after 12 consecutive stop-losses (equally distributed among the budget parts) your budget becomes 40% of the original. The more careful you choose when to trade, the smaller is the probability for a stop-loss to occur.

To compensate for possible changes in the market behavior over the long term, you can use several different algorithms which yield a profit in simulations.

Trading in traditional markets is different than trading in cryptocurrencies because the volatility is much smaller. Because of this, traders have to use leverage, because of this they have to use stop-losses, because of this they can't invest using a buy-and-hold strategy, because of this they have to use trading algorithms which make a profit which is smaller than a buy-and-hold strategy (when ignoring the margin liquidation requirements).



Trading simulation

Here is an example of simulated trading during a time frame which includes uptrends, downtrends and ranging, using EMAs crossover, for ETH-USD. The yellow squares are buys, the triangles are sells, and the red circles are stop-losses. The crossovers are filtered by some parameters because the pure crossovers would bring virtually no profit. The simulation includes buy and sell fees, a decent amount of price slippage for positions sized to about 10% of the actually traded volume, and leverage with a 40% margin liquidation level. The simulation doesn't include income taxes, which would decrease the profit further.

The resulted budget is increased 1.22 times with no leverage, 1.30 with leverage 2, 1.26 with leverage 3 (less than for leverage 2), 0.34 time with leverage 4 (which is less than initially). While shorting would bring a bit of profit during the down trends, they would add stop-losses.

You can see that the trading signals are well positioned at bottoms and tops, yet the result is inferior to buy-and-hold. During the same time frame the price rose 1.42 times. Even worse, daily cost averaging would have resulted in a profit of 40% (= a 1.4 times budget increase). So the (filtered) EMAs crossover is literally worse than the (daily) average. However, since EMAs crossover allows shorting during downtrends, it could be a safer trading technique.

When using EMAs crossover, leverage is good only during trending prices because it amplifies the potential profits (and losses), compared to investing. During ranging prices, leverage barely increases the final potential profit because the stop-losses are also amplified, but dramatically increases the potential risk of ruin. Due to the very high volatility of cryptocurrencies, leverage is much riskier than it is in the traditional markets.

If an algorithm makes less money than what buy-and-hold makes, the algorithm doesn't predict anything, it's a risk management algorithm (like many others); if leverage is used, ignore the margin liquidation requirements during buy-and-hold. Such an algorithm simply goes where the market goes, but reduces the risk (and profit) compared to buy-and-hold. It can still make a profit, too small to make anyone rich, but not because it predicts anything, but because it forces the trading to follow the prices for a part of the movement. Such algorithms are useful for entities which are already rich because a small percentage from a lot of money is still a lot of money.



Compounding

Compounding (of profits) can make anyone rich, but it doesn't work. In order for it to work it would be necessary for the price to move in the direction that you expect.

Let's say that you simulate an algorithm which does well for the simulated time frame, and get a set of parameters. Compounding would work if you could get the same profit for all future time frames. But here is the catch: this doesn't work. If you were to extend the simulation to a much larger time frame, using the same parameters, you would see that the total profit is nowhere near the compounded profit.

The reality is that the algorithm parameters would yield the same profit only if the price would move in the same way. So, basically, all you need for compounding to work is a price which moves in the expected direction, which is equivalent to knowing the future.

Compounding would also work if you could successfully profit from jumping from cryptocurrency to cryptocurrency, just before the price of each is about to raise significantly, which is equivalent to knowing the future.



Simulation details

Implementation details are far more important than what algorithm you use for entering / buying and exiting / selling, especially the details related to how you close the trade.

When you simulate a trading algorithm on past data, you have to be very careful about how you use the data from the moment of each simulated trading signal (which tells you to buy or sell).

The simulation algorithm has to iterate through all the candles, from the oldest to the newest, and for each candle (let's call it the reference candle) it has to go back a number of candles in order to gather the information required to compute the trading signals (which tell you to buy or sell during the reference candle).

A simulation will use the OHLCV (open, high, low, close, volume) of the candles. However because in real time trading the newest / current candle is being developed, its proper values (other than O) are unknown, so they can't be used until the candle is complete, which means that you can only buy and sell at the candle's open or close price (because you know when each occurs). It would be safe to use the values of the reference candle for signals, so long as you execute all the simulated buys and sells at the candle's closing price.

If a simulation shows a very high profit, it's most likely that you have used the values of the reference candle that you can't know during the reference candle.

A good implementation of an algorithm that uses a basic EMAs crossover, with no leverage, should yield a maximum profit similar with what buy-and-hold would yield for the same time frame. This should hold true no matter how short or long the time frame is; this is the reason why compounding doesn't work, that is, because it doesn't work for buy-and-hold.

Be pessimistic about your algorithm and presume that the buying price is going to be less favorable to you for most of the time.

It's best to display your trading signals on a chart, so that you can see how they all cluster, and how the losing trades cluster. If there is significant clustering, the repeatability of your algorithm is low, so you will likely not make money with it, and you might even lose money.



Leveraged trading

Leveraged trading allows you to amplify the potential profit and potential loss by a number, and is normally used in markets where the small volatility doesn't provide enough profit potential.

More interestingly, leveraged trading allows you to make a profit when the price of a cryptocurrency decreases, by short short selling the cryptocurrency.

Basically, when the price of the cryptocurrency is P1, you borrow (from the broker) cryptocurrency CC1 with which you buy fiatcurrency FC1 = CC1 * P1, hoping that the cryptocurrency's price will decrease.

The prices are expressed as P units of fiatcurrency for 1 unit of cryptocurrency ( fiatcurrency / cryptocurrency), written as BTCUSD (so the opposite of the division).

In order to get this loan, you need to reserve a collateral deposit (called margin) at the broker, in the shorted cryptocurrency CCOL = CC1 / L, where L is the leverage that you are using. L is an integer number, at least 2.

When the price of the cryptocurrency decreases to P2, where P2 < P1, you buy cryptocurrency CC2 = FC1 / P2 = CC1 * P1 / P2 with the fiatcurrency that you have obtained from the earlier sell (FC1).

However, you buy only enough to cover the loan from the broker, so only CC1 = FC2 / P2. This means that you only have to sell fiatcurrency FC2 = CC1 * P2.

The rest of the fiatcurrency is your profit FCP = FC1 - FC2 = CC1 * P1 - CC1 * P2 = CC1 * (P1 - P2) = CCOL * L * (P1 - P2).

Keep in mind that your margin must be able to cover, at all times, your loss, so CCOL * (1 - MLL) >= LOS. LOS = CC1 - FC1 / Px = CC1 - CC1 * P1 / Px = CC1 * (1 - P1 / Px), when Px >= P1.

This means that CCOL * (1 - MLL) >= CC1 * (1 - P1 / Px), so CCOL * (1 - MLL) >= CCOL * L * (1 - P1 / Px), so (1 - MLL) >= L * (1 - P1 / Px), so (1 - MLL) >= L * (Px - P1) / Px, so Px * (1 - MLL) / L >= Px - P1.

The broker will automatically close a short position if the cryptocurrency's price Px >= P1 / (1 - (1 - MLL) / L), when Px >= P1.

The broker will automatically close a long position if the cryptocurrency's price Px <= P1 / (1 + (1 - MLL) / L), when Px <= P1.

MLL is called margin liquidation level and it usually is around 0.4...0.5, but can be even 0.

Brokers automatically close a short position before its loss reaches the margin, in order to maximize the possibility to sell the fiatcurrency that you've bought, and buy the cryptocurrency that you've borrowed, ability which may be hindered by a limited liquidity when the price increases quickly.



To summarize:

  • You use the leverage L.

  • Your profit is FCP = CCOL * L * (P1 - P2), if P2 < P1.

  • The broker will close a short position if the price Px >= P1 / (1 - (1 - MLL) / L). For example, if L = 2 and MLL = 0.4 (40%), the broker will close the position if the price gets higher with more than 40% than P1.

  • The broker will close a long position if the price Px <= P1 / (1 + (1 - MLL) / L). For example, if L = 2 and MLL = 0.4 (40%), the broker will close the position if the price gets lower with more than 33% than P1.



Tips from others

Duomo Initiative - Financial education

Chris Dunn - Cryptocurrency lessons for new traders and investors

Chris Dunn - Prepare for the coming cryptocurrency bear market



Simulation software

If you want more information on this subject, search the Internet for "backtest trading software", "algorithmic trading software" or "algorithmic trading platform".

If you were to build your own simulation software, you would implement and know every detail of the simulation process, and you would be able to keep your algorithm private.

Multicharts

Ninja Trader

Quant Connect

Wealth Lab







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