Portfolio Recipes for Crypto Markets

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Last year cryptocurrency showed extreme potential for returns ranging from 10% to 1,000% per annum. Of course, in such a young and weakly regulated market, this high potential carried considerable risk. We recently analyzed risk and reward in this new environment. This article seeks to identify a good investment recipe that is fit to compete with a traditional “buy-and-hold” strategy.

As with any domestic project, from baking a cake to buying a car, investing in cryptos demands a plan. Think about it this way: when you need a new car, you don’t approach a dealership with a fistful of dollars and say, ‘give me a vehicle.’ This would be a recipe for disappointment. The performance will be unlikely to match expectations (for instance, if you received a compact car when you wanted an SUV) or the miles per gallon rating will make the car uneconomical (you’re stuck with the fuel consumption of a monster truck when your budget was more in line with a hybrid).

In short, you need to do your homework, define your preferences, prepare a plan, and execute it.

Let’s review the steps needed to build a workable approach for investing in the nascent cryptocurrency market:

 

A table representing EndoTech’s workable approach for investing in the cryptocurrency market
EndoTech’s investment approaches for the cryptocurrency market

The steps described above are shown in the following figure, which represents EndoTech’s methodology:

A graphical representation of how EndoTech’s algorithms follow a defined method to deliver the best results for its clients
EndoTech’s AI and ML-based Trading Algorithms Working Methodology

The following outlines each step in the EndoTech methodology:

  1. Establish A Risk/Reward Profile

The potential investor hopes for, or better yet, expects high returns with a low probability of losses. Yet, the uncertainty of cryptocurrency trading — especially in young crypto markets — compels investors to temper such expectations.

Before jumping in, the wise investor decides on their ‘pain tolerance.’ This means large exposure to market risk or accepting that a lower return is a price for lower risk. Once this is determined, progress can be made.

The right answers require the right questions. We don’t ask what investors want most since this invariably means achieving the highest return possible while experiencing no losses. We instead wish to know investors’ least tolerance before building appropriate strategies based on these constraints.

The following diagram summarizes an investor’s preferences regarding exposure to the market (in this case, to Bitcoin, given that existing data supports the hypothesis that it’s a good proxy of market dynamics).

Flow chart highlighting EndoTech’s hypothesis of market dynamics for Bitcoin using historical data and client’s preferences
EndoTech’s Hypothesis of Bitcoin market dynamics

Alpha Portfolio: Alpha is perceived as measuring a portfolio’s excess returns relative to an established benchmark. Investors who are not averse to higher risks that might generate a higher profit or steeper losses may consider selecting Alpha portfolio options.

We offer a methodology of daily rebalancing to produce returns from both bullish and bearish patterns. This methodology holds in all but two types of market conditions — the sidewise-trending market or sharp intraday reversals. Backtesting this approach produced the following results:

The benefits of EndoTech Majors Alpha compared to a “buy-and-hold” implemented in Bitcoin were as follows:

  • Returns on volatility – both during upward and downward trending prices
  • More than double the return — an annual return of 1,000% was realized relative to Bitcoin, which displayed a 360% return over the same period
  • Reduced risk – instead of experiencing a 66% drawdown during the period, EndoTech Majors Alpha experienced a 26% decline

Beta Portfolio: Beta is a measure of the security of a portfolio in comparison to the benchmark asset or the market as a whole. Beta portfolios are designed to suit investors who prefer lower risks that yield moderate returns. We offer a methodology of daily rebalancing to generate returns from bullish patterns while avoiding bearish patterns.

Benefits of EndoTech Majors Beta compared to a buy-and-hold strategy for Bitcoin:

  • Reduced Risk – instead of experiencing a 66% drawdown during the period, EndoTech Majors Beta experienced a 21% decline
  • Less downside on downward price movement – The strategy peaked near the Bitcoin peak
  • Constantly realizing returns – Delivers higher returns than buy-and-hold, which reflects both upward and downward momentum

Overall, annual returns of 700% were realized compared to a 360% annual return in Bitcoin. When it suits investors to do so, capital allocations can be split between Alpha and Beta portfolios to diversify overall risk.

2. Choosing Assets

Assessment of investor’s preferences is a function of the choice of assets to be included in the portfolio. After evaluating how much each asset contributes to the opportunity, how liquid it is, and how risky it is, the decision is made.

One asset does not dominate the other in such a young market, except for a few top majors. Instead, it seems more logical to differentiate by sector, technology, and type of asset. My portfolios mix majors and minors, sectors, and add gold, commodities, and fiat currencies with relevant leverage.

3. Choosing appropriate EndoTech Signals

Given the high volatility of the crypto market, the buy-and-hold strategy is rarely the winning one; for now, at least. Using artificial intelligence-driven algorithms to identify patterns, we can spot which assets are breaking out and when, their corresponding time frames, and their correlation. Everything is done to determine the optimal return targets while simultaneously minimizing losses—more on this subject in our upcoming blog post on Coin Rating.

4. Choosing EndoTech Allocation

When choosing how much capital to allocate to each portfolio asset to assure the risk/reward combination is in line with investor preferences, the main instrument available in finance is the Capital Asset Pricing Model (CAPM).

This model, used in traditional markets for more than fifty years, simply expresses the expected return on a security or portfolio as a function of the market risk premium, reduced by a factor (β) representing the risk/reward ratio.

Despite its age, the CAPM model has proved a valuable tool for optimizing portfolios within the cryptocurrency space. In this context, we leverage our know-how to create dynamic portfolio weights, helping optimize investment strategies and maximize expected outcomes.

5. Execution

As a young market, cryptocurrency involves a lot of uncertainty at the execution stage. Accordingly, we often ask, where should we execute orders, and how should we do it?

Fortunately, the situation for the investor is less complicated than for the trader. Nevertheless, it remains a delicate topic because if the investor cannot execute the order or the exchange is hacked, or files for bankruptcy, the investor carries 100% of the execution risk no matter how well the portfolio is managed.

We also caution investors about spreads and slippage — on some exchanges, bots benefit from market transactions. While a few percentage points on the spread don’t seem too high, during choppy markets, it can kill a portfolio’s returns when transactions may take place weekly. We offer you our Exchange rating on our Market Analysis page.

6. Choosing EndoTech Money Management

Money management is the mathematical process of increasing and decreasing the number of contracts/shares/options. The purpose of utilizing money management should be to increase the returns during positive runs and protect those returns during losses.

Money management is represented by the ensemble of decisions and strategies defining how we reinvest the returns or handle losses. In this respect, money management really can move the needle for investment returns.

There are many aspects and methods — compound versus fixed, active capital percentage, fixed dollar amount, the percent at risk, trading with optimal F, and many more. For example, we believe that in a market like cryptocurrencies, where results can be as high as those available in leveraged markets, most of the models will be considered too extreme. Yet, since investor appetite is high, we use 90% of the capital as active capital, and a compound reinvestment strategy to keep up with Bitcoin returns.

To review the output of this process, check our detailed portfolio reports (backtesting results).

We are not financial advisors, and we are not recommending that you follow the system. We share what we consider to be previously applicable in such markets but caution that we cannot guarantee that this same strategy will work in the future.

When you subscribe to Portfolios (available from EndoTech.io since April 1st, 2018), receive daily real-time reallocation signals for each portfolio.

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AnnaBecker

AnnaBecker