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Crypto Assets - Balancing the Basket

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Today's discussion is one which will send many crypo-traders into a riotous frenzy. In this market many traders are of the belief that high frequency, short term trading patterns can pay off due to its fast paced volatile movements.

While this may or may not be true, it does leave one of the most important lessons of both investing, and trading, at the door - without context or discussion by most writers.

Long term goals
There is little in investing, or trading, which is more important than setting long term goals. Really you could make this argument for just about every area of your life, but its extra important with so many fast paced, and dynamic influences being accounted for (or not). We must set expectations of ourselves. We must have metrics to measure success and failure. We must make decisions - sometimes in time constraints - which are in line with long term motives and plans, or we will fail. The pits of a market are not the place for emotion, or guesswork.

Picking Positions
Its important to think of positions in the crypto market similarly to any other market. Never forget that "cash" or in the crypto marketplace "fiat" is a position. Picking a position is a vital part of investing and trading alike. It is literally art, and we use the science to explain, and predict the art. I don't want to go too far into the picking portion in this write-up. Lets look at some long term plans with regard to what we want to pick. I believe in picking assets which make long term sense. I look at projects which appear to be among the best, or clearly the best in a use case in this market place.

Probable use cases of Decentralized Blockchain
1.) Remittance and FinTech
2.) Distributed Services, (DAPPS, Governance, Tracking, Logistics, Supply, etc.)
3.) Production level long term stable decentralized ledger for data, analytics, and value

Subsequent Positions & Holdings

Fiat/Cash this is at times a position awaiting better market entry conditions
XLM Lumens - ICO's on a super fast chain, super cheap transactions, excellent settlement with asset swapping (exchanges) -- Asset Class 1
LISK - blockchain as a service (sidechain), DPoS, speed, flexible SDK (.js programming), Great future governance -- Asset Class 2
Bitcoin - stability, production value, longevity, proof of concept -- Asset Class 3

Pruning difficult decisions
A large part of trading and investing is about discipline. There are terms which have developed in the crypto marketplace to describe the emotional ebb & flow of a trader: "FOMO", "weak-hands", and "FUD". These are all terms which in every other marketplace are not required. Difficult decisions require discipline in the market. Namely being willing to "call a bottom" to buy, and "take profits" through the top of the market. These two things are difficult, and many traders struggle with the buying aspect. Most investors struggle with the selling aspect. Both of these "weaknesses" in strategy can be accounted for with some long term planning. The bottom line is traders and investors both must be ready and accustomed to stomaching ugly bottoms, and exciting tops with little emotional input.

Re-balancing a Basket of Assets
To be continued...

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Rebalancing is a tool most commonly used by Investors. It is useful because it keeps an Investors Risk Management in correlation with their Risk Appetite. This is important, especially for long term holders. In a group as volatile as Crypto, it is even more important - as it lends well to to explosive compounding and can lead to wildly unbalanced portfolios in a relatively short time. One of my favorite examples of re-balancing (and the only one we will discuss here) is practiced by selling and buying based on risk thresholds. A threshold is set like so:

Define a risk appetite (percentage of holdings to go into a given market)
Define a risk factor (percentage of individual positions of a given class of holdings)
Manage risk (buy or sell from a position to meet the percentage guidance originally set)

I'm not advocating selling due to the portfolio being out of balance. I am advocating letting the balance of the portfolio be an indicator of when you need to lighten up on an asset. It can and should be something to watch in most crypto portfolio's with the intent of bringing the portfolio back to the balance originally described in your long term goals. Lightening a holding due to it being to large in the division of investment and reallocating those funds to another portion of your portfolio is smart. For a trader, this makes for more weapons to trade with.

The Risk Managed Basket
To be continued...

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Define a risk appetite
Try to keep in mind diversity in investment is one of the most important pillars of asset speculation. Asset allocation is king - how to define this, and what to do with it is the harder part. This is a rather personal decision for most investors/traders. I find all to often that crypto traders/investors are treating this market more like a lottery ticket than an asset. I cannot advocate that. Simply put, if you are overweight in crypto by a factor over 50% you're probably in the "lottery ticket" analogy, and need to rethink your overall portfolio immediately. I cannot in good faith advocate a risk appetite higher than 50% with all of the other assets available to either the trader or investor in todays global economy, and global markets. Even a specialized investor who's comfort and knowledge greatly outpaces every other market type - in favor of cryptocurrency - should have diversity in other markets leading to an overall exposure of not more than 60%. Ever. (Maybe 1% of traders and investors fit into that category). This really is all I can say on the risk appetite subject. Make your own wise decision - for those of you who don't know where to start, I recommend looking at the modern portfolio and consider this risk to be similar in line with forex as far as exposure. A good figure for a conservative investor is probably between 9-12%. Riskier investors may be more willing to drift between 15-24%. Investors with more specialized knowledge in the crypto field can probably tolerate 25-39%. Above this threshold is generally reserved for investors and traders beyond the scope of this article. (Again less than 1% of the markets participants)

Define a risk factor
For our basket of crypto (listed above) we have to make some decisions. personally I'm a big believer in all of these coins and would love to throw money at them. That's why I follow rules. This is where we get down to brass tax. We look at our 3 asset classes (or subclasses really) and define them with risk in mind here:

1.) Remittance and FinTech

Many financial companies are interested in private chains
Many financial companies are interested in permissioned chains
Financial companies can be slow to move - and offer little direction speculation

2.) Distributed Services, (DAPPS, Governance, Tracking, Logistics, Supply, etc.)

Many of these services are best provided by completely different projects
Multiple projects overlap greatly in application
Barriers to use-cases such as software development kits, developers on project,
and time in production make speculation difficult with new starters nearly every day

3.) Production level long term stable decentralized ledger for data, analytics, and value

The dinosaur in a fast moving field - network effect may not be enough
Use cases can be applied to other more flexible tech
Mud-on-the-face the oldest production chain has had many instances of bad press

With these risks in mind we must design an allocation for these holdings. I think its fair to name Class 3 as the most conservative, Class 1 as more risky (single sector use case) and Class 2 as the medium risk choice. With this in mind I would subject overweight status to Class 3 holdings, and underweight to Class 1. An example:

25-44% Class 1 -- Positions effected: BITCOIN
19-36% Class 2 -- Positions effected: LISK
11-24% Class 3 -- Positions effected: STELLAR
5-25% Liquid -- This can be fiat, or a benchmark piece of crypto typically used for transition to one of the asset classes.

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Manage Risk
This is the trading part. The idea of aligning each of the positions in the portfolio to fall in line with our long term goals. I have set thresholds for each class which we do not want to break. If we are breaking those thresholds we need to explore why and look to liquidate (take profit) in those positions to help align our overall strategy back to the long term goal. This goes for buying as well - when we see an asset getting significantly underweight, most often this is a buying opportunity we need to be paying attention to. Patience is of course no less important than always, but we must keep an eye on these levels and let them indicate where we go next -- but not necessarily when. That's why we're traders, and not just purely investors.

Buy and Sell indicators
To be continued...

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This is an example taken from a LISK chart I had mocked up.

Fibonacci resistance arcs are one of my favorite tools. I highly recommend there use in crypto. They are cited as illuminating the experience trader to "hidden support, and hidden resistance area's". I couldn't agree more. My personal style is to mark areas of strong support, strong resistance, and to show long term trend lines. Then I find rallys and downtrends, and place fib arc's on them. From here, I start looking for points of future intersection. Generally I can make some deductions as to what these indicators are telling me. Keeping an eye on volume, I can begin plotting a more precise forecast for the asset.

This example is taken from a BTC chart with Daily timescale. Again, you can see the use of multiple indicators used to forecast the trend. This in conjunction with measuring our asset allocation can tell us whether our portfolio is ready to acquire - and if the asset is ready to accumulate. If both are true, its BINGO time!

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Taking Profits like an Investor
Another tricky subject for those of us who are more inclined to be good investors, is when to sell. Thankfully most of the exchanges you will deal with in the crypto investment space will allow stop-limit's and some allow trailing stops. While I've had limited success with trailing stops due to the volatile nature of crypto, I do regularly employ stop-limits. In conjunction with Technical Analysis, I find one successful approach is not to try and find the top -- but instead to roll a stop-limit at the fib retracement level of 23%. Following this guide, and bumping it up to follow that fib level will survive historical back-tests showing great long term calls on tops.

Even better, is taking into account our balancing strategy.

Tiered Accumulation and Distribution
While selling your entire position at a 23% fib would make sense, by and large it would make even more sense to set a system of stop-limits with eyes on selling portions of your positions at different fib-retracements. Say 15% at 23.6% 20% at 38% to help take profits. This allows your holdings to be more flexible in a high volatility environment - but can help you take profits when "the dip" comes. This strategy can work very well over the long term - and I highly recommend its use, especially for new crypto traders.

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