To HODL or to Trade?

Proceed with Caution, Proceed with a Plan

I was going to close this series of articles with results from a backtest of buying and selling Bitcoin over the last Halving cycle with signals from a Future Supply Model and a Lindy Model. I will do that in the next article. I now realize the series needs to be longer for a little discussion of HODLing vs. trading.

So in what is now a five article series, the next article will close with back test results for methods that could outperform Buy and HODL.

This is not investment advice. Bitcoin is highly volatile. Past performance of back-tested models is no assurance of future performance. Only invest what you can afford to lose. You must decide how much of your investment capital you are willing to risk with Bitcoin. No warranties are expressed or implied. 

First, in this article, we should talk about HODL or Trade:

Accumulate and HODL First

Yes, HODL, hold on to Bitcoin. 

Why? because the long term trend is strongly upward. Whether one uses a Stock-to-Flow model, or a Future Supply Model, or even a simple time-based Lindy model, the upside is substantially greater than the downside. For example, a regression on 10 years of Bitcoin monthly data with the Lindy model shows long-term value rising at B^5.3 where B is the number of elapsed Block years, or simply the block height.

Bitcoin is highly convex and positively skewed. Bitcoin might lose most of its value, but it could well go to six digits in dollar terms or higher, which is a factor of 9 upside or more from here.

But the drawdowns can be brutal, exceeding 80% . And human psychology hates losses twice as much as it loves wins. Plus recovering from an 80% drop requires a gain of a factor of 5.

So you want to trade?

Ok, trade fiat: stocks, options, bonds, commodities, foreign exchange. Use your winnings to buy more Bitcoin, especially when prices are relatively low. If you lose, it’s only fiat, they will print more.

Save in appreciating Bitcoin, spend in depreciating fiat.

You want to trade crypto?

  1. Why would you waste your time with intrinsically worthless alt-coins, and coins without absolute scarcity and mined with the Proof-of-Work mechanism? The #2 coin, Ethereum will abandon PoW. Alt-coins are all centralized to varying degrees.

  2. Ok , you want to trade Bitcoin. See above: HODL

Finally, having considered all of the above, you have decided you want to trade Bitcoin. You want to trade so that you can increase your long run holdings. You might decide to take some gains off the table before the next big bear market, if you have a rational, systematic way to get back in at a lower price.

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Can you Make Volatility your Friend?

Why not take advantage of the volatility? But you must have a clear plan.

Okay, here’s the deal. Whatever your model, Bitcoin is highly volatile, with one standard deviation movements of greater than a factor of two over long time periods. Two standard deviations is close to a factor of 5 away from a Future Supply or Lindy model’s fair value.

Do you know how to trade such a high volatility product?

The 52-week range at present is a factor of 3 in price. The average daily volatility is 2.29% in USD terms. That translates to 44% on an annualized basis; it’s settled down somewhat for now. Apple stock has similar volatility. 

You can make volatility work for you, if you are patient and wait for long term entry or sales points.

You need to be very selective when selling since the long term trend has to be presumed to be strongly upward.

So you’d better be good at being patient, for good entries and exits.

You should probably only trade with 1/5 or 1/4 or your holdings. HODL on to the remainder, the 75% or 80%. Then it’s somewhat like trading stocks with only a small margin balance. Have a core position and accumulation schedule that puts you on a trajectory to your big objectives.

Any HODL plan is probably an accumulation plan, so you are already ‘trading’ the long side. If you make equal dollar purchases each week or month, you are automatically buying more at lower prices, less at higher prices with DCA, dollar cost averaging. You probably have some dream you are working towards: whether retirement, a house, your child’s education, perhaps a Lamborghini.

So a first method could be to simply have a regular accumulation schedule without any consideration of price signals. A second method  is to buy extra when the price is very low, and avoid purchases when the price is too high. Buy or buy more or hold only are your choices. This second method has no sales.

A third method is to add sales of part of your position when the valuation is extremely stretched, say one and a half or two standard deviations or more above the model. So you are buying and selling but with a method tilted toward more buying than selling, since overall you are seeking to accumulate the world’s hardest currency. The third method should have no short sales and not touch your predetermined core holdings.

In the next article we will compare continuous dollar cost averaging with buying only when the price is below the model (second method), including larger buys with highly oversold prices. We will look at both Lindy and Future Supply models, and in both cases the backtest shows the selective buying method outperforms.

We then look at the third method with judicious selling when prices are highly stretched above fair value. This method performs the best among the three. Where DCA (first method) had a Double your money result backtested over 4 years, favorable buys (second method) led to a Triple of your capital, and favorable buys plus selective selling (third method) led to roughly a Quadruple of the USD value of Bitcoin holdings.

The key is to be patient, systematic, and judicious about buying and selling. Make volatility your friend.

The final article in the series will present the details of the backtest results, now that you know the general approach for each of the three methods.