What does hedging mean? Basically when the market goes against u, u limit your losses. Of course your cut of the profits will be lessened as well, but in times of volatility, and there's always volatility in crypto, some knowledge of hedging is always useful to protect your heard-earned crypto gains. For most traditional assets (stocks, bonds etc.), various readily available derivatives options serves to fulfill the need for hedging. However, even as we're starting to see various instruments such as bitcoin futures, this function is still relatively immature in the Crypto space.
So where do we start?
Some experienced crypto-investors may say that the only strategy you need is to diversify your portfolio into a wide array of tokens, in not just the NUMBER of tokens or use-cases, but in their 'industry' or use-cases as well (e.g., e-money tokens, protocol tokens, utility tokens). That might work well for the mature equity markets, but crypto participants would realise that the crypto market is extremely correlated. When some event occurs to disrupt the confidence in bitcoin, or the crypto-sphere as a whole, the whole market tanks together. Once rallies come, >90% of the market shares in the gains. Just look at the 1-hrly or daily % changes on coinmarketcap, u'll see that the degree of co-movement is very high.
While various strategies involving leveraged margin longing or shorting, or even the newer crypto-derivatives exist, this post shall focus on a simpler strategy, i.e., rule-based cashing out and re-entry based on periodic portfolio changes. To illustrate this, let us take a period of high volatility, say the last three months, and construct 3 hypothetical portfolios with a mixture of fiat/btc/eth/random altcoins holdings.
[For the purpose of this exercise exercise, the following prices scrapped from coinmarketcap was used. (Link to table image at
https://www.dropbox.com/s/qg3gzc4bawqpal4/table1.png?dl=0) ENG/ZRX/BNB/AIR were random alt-coin picks across a variety of purposes and marketcap.]
Now let's set some rules for each portfolio:
A. 30% Cash, 15% BTC, 15% ETH, 10% of ENG/ZRX/BNB/AIR each @start, HODL.
B. 30% Cash, 15% BTC, 15% ETH, 10% of ENG/ZRX/BNB/AIR each, WEEKLY REBALANCING*
C. 30% Cash, 15% BTC, 15% ETH, 10% of ENG/ZRX/BNB/AIR each @start, CUSTOM RULE**
*Rebalancing: i.e., when the price of a token runs up, relative to others, and its share in your portfolio rise, u sell some, so that it's share in your portfolio stays constant over time.
**CUSTOM RULE: 50% profit-taking (of weekly gains) when weekly portfolio change is > 30%, Re-entry of 50% of available fiat balance when weekly portfolio change is < -30%
Voila, the results are as follows.
A B C
20171119 10,000 10,000 10,000
20171126 12,608 12,608 12,608
20171203 12,986 13,239 12,986
20171210 13,371 13,682 13,371
20171217 19,704 19,916 19,704
20171224 20,544 21,023 20,292
20171231 29,320 27,228 27,377
20180107 55,215 43,040 45,387
20180114 61,577 46,558 48,570
20180121 47,609 39,662 40,969
20180128 44,626 38,219 39,000
20180204 32,593 31,384 32,852
20180211 26,651 24,590 30,753
Some key takeaways here,
- The weekly rebalancing portfolio (B) delivers returns which are on par, or worse off than the reference HODL portfolio (A).
Intuition: This could be because the idea of mean-reversion of returns, i.e., when people expect prices to always drop after rising for some time, or trend up after declining for some time, might not hold true for individual tokens in crypto, due to token-specific factors (gd/bad news, team issues etc.) which can often cause moon or doom scenarios.
- The 'take-profit' portfolio does quite ok. It seems to be the most resilient in the last few weeks, when the entire crypto market took a beating. Note that the cash-out rule kicked in 3 times over the period, while the re-entry rule did not kick in at all. No declines exceeded -30% (or even -20%) on a weekly basis. Caveat: It is very likely that if the data frequency we were using were shorter in intervals (e.g., two-day changes), this portfolio would have performed even better. I recalled there were multiple times when the market tanked significantly over a short period, and ran up for 1-2 days subsequently. The re-entry and cash-out rule would have benefited significantly from such short-term volatility.
This post is not intended to tell u to follow the strategy above. It IS intended to tell u to learn to develop your own strategy over time, based on your own set of trading rules and intuition. Those who outwins and outlasts everyone else in Crypto are often those who know what they're doing. With 2017's huge run-up in market cap alrdy, it's probably a bit too optimistic to depend on 'luck' alone in trading.
As promised, those who wish to have a copy of the excel and play with the parameters for themselves (including tinkering with the custom rule) can get it here
https://www.dropbox.com/s/vskcfdcwu274cjc/Portfolio%20Simulations%20Excel.xlsx?dl=0. Have fun folks.
