After the disastrous start to the year for Bitcoin (COIN, OTCQX:GBTC), many investors have been left wondering how to proceed. One on hand, investors who witnessed the end of year rallies in 2017 know how quickly the market can turn around and do not want to be left behind if Bitcoin surges. On the other hand, the sharp corrections often following bull runs have left an indelible impression on investors and many now patiently anticipate these corrections before buying in. In this article, we’ll show an analysis of historical data to attempt to shed light on how best to invest in Bitcoin.
(source: Moneycontrol.com)
FOMO
FOMO, or the Fear of Missing Out, has been exemplified by the rush of investors buying in during the latest Bitcoin bull run in late 2017. Many investors not only rushed to buy in, but bought on margin or using credit, which can never be recommended for such a volatile asset. The idea behind FOMO stems from a very primitive herd mentality instinct. If one observes Bitcoin rising by $1,000 every few minutes, as seen during the height of the madness, one naturally extrapolates the trend and forgets the downside.
To simulate FOMO behavior, we’ll use historical intraday Bitcoin prices as well as Google trends data, both pulled from the Cryptory package in Python. This data begins in April 2013, which is a good starting point for us, as Bitcoin had climbed to over $100 and was beginning to become more widely known. In this simulation, we’ll follow FOMO Fred, who exhibits the following behavior meant to model an investor who buys in during periods of hype and then panic sells during subsequent dips:
- Fred buys into the hype with $1,000 when both the Bitcoin price and Google search interest jump 30% over the average for the past seven days. We’ll assume he buys at the close price of the day.
- Fred will sell when he gets spooked by observing a 30% decline from the highest price after he buys in.
Here are Fred’s returns:
Date Bought Buy Price Date Sold Sale Price Profit 11/8/2013 $338 11/19/2013 $585 $729 11/27/2013 $1,002 12/1/2013 $956 -$46 1/26/2015 $273 1/31/2015 $217 -$205 11/3/2015 $403 11/10/2015 $337 -$165 12/7/2017 $17,900 12/22/2017 $13,832 -$227 Total $86
Despite being an investor in Bitcoin since 2013, Fred has managed to scrape together a paltry total profit of $86. Note that it is not necessarily the FOMO mentality that hurt Fred, as he would have been massively profitable if he held long-term. It is the buy the hype mindset, paired with impatience and panic selling that led to mediocre results for Fred.
Buy the Dip vs. Holding
Now that we have shown that buying the hype without holding doesn’t work, we will compare simply buying and holding to waiting for a dip to buy. With all the frequent peaks and valleys in crypto markets, it seems that the only constant is change. Therefore, many investors believe that there is always a healthy correction around the corner, no matter how solid the fundamentals may appear to be during a bull run. In the next two simulations, we’ll examine a strategy that waits for dips to buy in and compare this with a simple buy and hold strategy.
To simulate the buy the dip strategy, we’ll consider Dave the Dip Buyer and use the same historical dataset as before with the following rules:
- Dave will buy the dip with $1,000 when the price crosses below 70% of the average of the previous seven days’ prices. This simulates a patient investor who waits for a sharp correction to invest. We’ll assume that Dave is able to buy in midway between the low price and the close price of the day, since he’s carefully watching and waiting for the dip.
- Dave will sell once the price doubles from his buy-in price.
Here are Dave’s returns (with a present Bitcoin price of $10,000):
date bought price Profit 12/7/2013 $669 $1,000 12/8/2013 $733 $1,000 12/18/2013 $472 $1,000 12/19/2013 $597 $1,000 1/14/2015 $175 $1,000 1/15/2015 $193 $1,000 12/22/2017 $12,832 -$283 Total Profit $5,717
As you can see, Dave has been vastly more successful than FOMO Fred, due to his patience in selecting a buy-in and the fact that he is willing to hold until he turns a significant profit (in fact his latest trade has not been realized yet, as he is still bagholding). It certainly seems like this is a very viable strategy giving the frequent swings in Bitcoin. Does this strategy beat simply holding?
To model holding, we consider Harry the HODL-er. Harry is a big believer in Bitcoin and blockchain technology, so he resolves to invest for a longer horizon. In 2013, he buys 7.45 Bitcoin with $1,000 and plans to sell 20% of his Bitcoin at the end of every year to take some profits. Here are his results:
Date Price BTC BTC Value Cash out 4/28/2013 $134 7.45 $1,000 12/31/2013 $754 5.96 $4,495 $1,124 12/31/2014 $320 4.47 $1,431 $477 12/31/2015 $431 2.98 $1,283 $642 12/31/2016 $964 1.49 $1,436 $1,436 12/31/2017 $14,156 0.00 $0 $21,096 Total Profit $24,774
As you can see, Harry’s results blow buying the dip out of the water! Not only is his strategy the most profitable by far, but it is extremely simple and foolproof as well. Even while consistently taking profits every year, Harry was able to generate an enormous return. Of course, Harry got lucky by buying in for a low price, but even if Harry bought at the same price as FOMO Fred’s initial buy, he would have made nearly $10,000.
Summary
In conclusion, we must refer to the oft-quoted Warren Buffett to make sense of what we’ve seen in the historical data:
Although past results are not necessarily indicative of future performance, the data shows that patience has certainly been a virtue with Bitcoin investing. The landscape of the Bitcoin market has evolved significantly over time, but we believe that Bitcoin’s fundamentals are as strong as ever. To invest successfully in such a novel, volatile asset as Bitcoin requires nerves of steel to be able to hold through downturns and reap the rewards as adoption of the technology grows.
Zen Analyst
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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