TRIAGE FOR THE LOSING TRADER – THE PORTFOLIO

>>>Part I – Stop The Bleeding
>>>Part III – Coming Soon

Download here: Triage for the Losing Trader: The Portfolio

If you liked the material here and you would like face-to-face help on Portfolio Management and creating a solid foundation with which to generate profits, you can purchase a one-on-one with the author here.

Quick and Clean Portfolio for the New Speculator:

  • 30% BTC: Long term cold storage (never touch) (1).
  • 20% ETH: Long term cold storage (never touch).
  • 25% Alts: Long term cold storage, 5 alts at 5% of portfolio each, sell 25% of an alt every time it’s USD value 2x’s (profits go to FIAT pool)
  • 15% Trading: Practice trading. Never all in (2).
  • 10% FIAT: Profits from altcoins and trading go to here. Use this FIAT to buy the dip on BTC with dollar cost averaging.(1) “Never touch” means to not sell until the money is needed for expenses or until it has grown to a life-changing sum.
    (2) Triage for the Losing Trader Part III will focus on how the NS should go about managing their educational-trading portfolio allocation.

Preface

This paper is part two in a series regarding risk management, intended for those who have lost significant money speculating in cryptocurrencies. Part one, Stop the Bleeding Now, characterizes the new cryptocurrency speculator (NS), discusses common mistakes, and suggests ways to avoid unnecessary loss in the future. In this installment, we will explain the fundamentals of portfolio diversification and how to create a balanced portfolio of your own. This paper does not give financial advice. It is a collection of common and generic investment guidance, fitted for the cryptocurrency space.

Background

The parabolic runup of late 2017 took many new speculators (NS) on a wild ride of elation, rewarding everybody invested in the space with spectacular gains regardless of their level of planning or applied rationality. As possibly the most powerful bull run in the history of financial assets, this runup even popularized the “just HODL” attitude and subculture: an idea that simply holding one’s crypt would yield enormous returns.

When Bitcoin and cryptocurrency began their dramatic correction, the “just HODL” strategy showed its weakness. HODLing came under scrutiny because the vast majority of NS were proving terrible at it. The problem was not that the strategy was a poor one (we will promote strategic holding in the following sections), the problem was that the strategy was too emotionally taxing for the average NS to follow. This over-simplified strategy was a symptom of a market deluding many new investors into believing that gains could be made and protected without much thought.

In Triage part one, we saw the mistakes NS most commonly make and discussed in detail the pitfalls of fear and greed. Now the question is, how should the NS re-approach cryptocurrency? In this paper, we will explain how simple portfolio management will allow the NS to hold through corrections without capitulating or buying into others’ fear and continue to advance their trading ability with minimized risk.

Fundamentals of The Basic Portfolio

A balanced portfolio is both a distribution of assets across types and a set of principles guiding its own maintenance. The losing trader or new speculator should build a portfolio that:

  1. Allows trading practice while minimizing the amount that could be lost through trading
  2. Scales allocation based on risk level
  3. Reduces the psychological difficulty of maintaining the portfolio itself

The first goal, to allow trading practice while minimizing the amount available to lose through trading, will dictate how the NS’ portfolio is split into holding and trading sections. As established in part one, the NS has probably demonstrated to his or herself that they are still a losing trader, both in Satoshi and USD terms. The first goal should be to stop losing money, and second to begin learning to make money. Therefore, it makes sense for the NS to trade with a relatively small amount of their portfolio. Holding long term would be preferable to trading more of a portfolio, which risks higher Satoshi loss. For this reason, the remaining majority of the NS’ portfolio should then go into long term hold positions. A holding-heavy and trading-light portfolio will allow the NS to practice trading while minimizing their Satoshi losses.

The second goal, to scale allocations based on risk level, dictates how the NS’ long term hold positions should be sized – that is, how much of each coin the NS should hold. There a variety of ways to do this (a couple of examples will follow this section). The differences between allocation scaling strategies lies in different interpretations of what “risk” means. At the most advanced levels of investing, risk is measured as a product of statistics and heuristics involving volatility, correlation with hedging instruments, and often proprietary methods/data. For the NS’ purposes, simpler interpretations of risk will more than suffice. For example, a coin can be considered riskier when it has a low market cap (Market Cap = Price X Number of Coins in Circulation ) (market cap data can be found at coinmarketcap.com). An NS might also rationally estimate riskiness by assigning a number value to how far a project is into its roadmap (ex: pre-ICO being the most risky, post-main-net launch being moderately risky, and significant platform adoption being the least risky). Regardless of which method is used to determine risk level, the NS should ultimately allocate the largest portions of their portfolio to the least risky coins they can find, and the smallest portions to the most risky coins.

This simple risk management setup serves the NS in two ways. It drastically decreases their overall risk level, as compared to the situation described in part one (plagued by all in plays and huge portfolio repositioning), and it provides the NS a rationale for their overall cryptocurrency holding distribution. This second benefit (simply having an established and rational strategy) fulfills the third goal for an NS portfolio; to reduce the psychological difficulty of maintaining the portfolio itself. Having a reason for the size of each bag held will give the NS considerable willpower in the struggle against rash and emotional decisions. For many newer traders, a lack of rational structure made it easy to stray from trading plans in the past. Many NS painfully remember how they broke from an initial plan of simply HODLing to attempt trading. Now, armed with a rational guide to portfolio management, the NS has a much better chance of sticking to their plans.

Example Portfolio 1

Now that we understand the underlying principles of a simple portfolio, we will move into examples and explain the rationale for each. We begin with the “Quick and Clean Portfolio for the New Trader,” which was listed at the start of this paper:

  • 30% BTC: Long term cold storage (never touch).
  • 20% ETH: Long term cold storage (never touch).
  • 25% Alts: Long term cold storage, 5 alts at 5% of portfolio each, sell 25% of an alt every time it’s USD value 2x’s (profits go to FIAT pool).
  • 15% Trading: Practice trading. Never go all in.
  • 10% FIAT: Profits from altcoins and trading go to here. Use this FIAT to buy the dip on BTC with dollar cost averaging.

When analyzing any portfolio, especially one made by an NS for his or herself, one should first rationalize each allocation in the portfolio, and then ensure that the portfolio as a whole meets the goals laid out in the previous section (ask: does it reduce trading risk, does it scale positions by risk, and is it a plan that I can stick with).

The first 50% of this portfolio is in the two largest cryptocurrencies by market capitalization, Bitcoin and Ethereum. Bitcoin is the gateway coin that the altcoins are traded against most predominantly. Because the altcoins generally respond to Bitcoin’s rise and fall, they are comparatively more volatile – this justifies Bitcoin’s place as the largest, least risky (besides FIAT), allocation in the portfolio. Ethereum makes up 20% of the portfolio because it is the second largest coin by market capitalization, and because its platform is widely used. Many major tokens are ERC 20 (on the Ethereum blockchain) and most ICOs raise capital with ETH. For a portfolio that wishes to capture the value of cryptocurrencies as an emerging market, Ethereum warrants a significant allocation.

Bitcoin and Ethereum earn the largest allocations because they are deeply connected with the entire cryptocurrency market. Bitcoin leads the market and Ethereum measures the strength of the ERC20 tokens and ICOs. Cryptocurrencies are notoriously transitory; many of the top 100 coins were only recently conceived, and many of the top 100 coins will fail within the decade. In such uncertainty, the lion’s share of this portfolio is rationally dedicated to the largest and most stable coins available.

Along with a rational entry for BTC and ETH in 30% and 20% allocations respectively, we also need to have a rational exit plan. Having a plan for both entry and exit is essential for the NS to prevent unplanned and emotionally driven exits. This example portfolio plans to hold BTC and ETH until either the money is needed for personal expenses, or the value of the holdings reaches a life changing sum of money. This plan intentionally does not allow the NS to sell their long term BTC or ETH because they think they can re-buy cheaper; allowing such actions would turn these large holds into trading allocations. As explained in part one, the NS should reduce their trading while he or she is still a losing trader.

The other half of this example portfolio is divided into three parts: long term altcoin holding (25%), trading practice (15%), and FIAT (10%). These allocations serve to capture the value of promising but risky altcoin projects, allow trading without risking a large amount, and allow the NS to buy into Bitcoin corrections. These sections of the portfolio also come with some rules regarding how they are to be managed. While it makes sense to have only rules for long term exits on Bitcoin and Ethereum, some active management rules for altcoin, trading, and FIAT allocations are necessary.

Altcoins represent a great deal of unrealized potential value in the cryptocurrency space. With some careful fundamental analysis and luck, a value investor might be able to invest in a few projects that will eventually reach mass adoption in their target space. This example portfolio gives a 25% allocation to altcoin holding, to be divided evenly amongst 5 picks (5% of the entire portfolio each). With evenly distributed position sizing, the portfolio holder is hoping that at least one of the projects will make it through the early phases of cryptocurrency and yield massive return on investment. Depending on the project, this could be as much as 50x over several years (think buying into AOL or IBM in their infancy and the infancy of the internet).

With even position sizing, only one of the five altcoin picks needs to grow greater than 5x, even if all the rest fail completely. For example, pretend that we invest 1 dollar into each of 5 altcoins, and four of them go to zero. To profit overall, our remaining altcoin need only to grow 501% – from $1 to $5.01. This is very reasonable over many years, considering how many altcoins more than 10x in only one year.

However, this altcoin allocation is not just built for finding one or two gems in the very long term. The plan also includes rules for taking profits in stages, should the altcoins profit incrementally. By taking 25% profit whenever an altcoin increases in value by 2x, we can secure profits over time, even if any of the altcoins eventually fail completely. It is worth noting here that this plan measures growth of the altcoins in their USD, not Satoshi, value (1 Satoshi = 0.00000001 ฿). Profit taking is structured based on USD value, because the investor wants to have the potential to enter low market cap coins whose prices are not affected by BTC price and exit into the FIAT pool (which is the last part of the portfolio).

The second to last section of this example portfolio is the 15% trading allocation. The rationale for trading with only a small amount as a new speculator is explained in detail in part one. The specifics of how to trade with this allocation will be explained fully in Triage part III. In this part, we will limit our discussion to what might be done with trading profits, as they are part of the overall portfolio.

This example portfolio stipulates that profits from trading will be placed in the FIAT pool (which will be used to buy BTC in pullbacks). However simple this might seem, the process of taking trading profit can be nuanced. In portfolios where trading profits are not put directly back into future trades, putting profits aside from every winning trade can lead to unintended consequences. Namely, over time the losing trades will bring down the total Satoshi value of the trading allocation, while the profiting trades will have their profits taken away (in this case, taken away to the FIAT pool) and not returned to the trading pool to offset the losses. As both wins and losses are inevitable in trading, this setup will slowly decrease the trading allocation down to nothing.

We can avoid this problem by using a running total for profits. This means that “profit taking” only occurs when the total trading allocation is over its allotted 15%. Instead of taking profits on every winning trade and sending them straight to the FIAT pool, we first check whether the winning trade has pushed the trading allocation value to over 15% of the total portfolio. If the trading section is larger, then we move the excess to the FIAT pool. If the trading section is still smaller than 15%, even with this recent win, then no profits are moved to the FIAT pool, and we continue to trade. Now all there is left to explain is the form and function of the FIAT stockpile.

For the long-term sustainability of a portfolio, it is very important for an NS to have a strategy to deal with corrections. If there is no way at all for the NS to actively respond to a macro correction in BTC and cryptocurrency in general, then the psychological temptation to stray from a majority-holding plan will be quite enormous. This example portfolio does offer some respite in the form of the 15% trading allocation, which will undoubtedly be used in some attempt to play the correction (be it through shorting or otherwise). However, we already know the significant risk of loss that trading brings to the NS, especially in a downtrend.

A great relief to the psychological pressure to “just do something” in the face of a red week or month is to have FIAT on the side that can be used to buy into the dip (the details of disciplined dollar cost averaging will be discussed in part three). For this tactic to be possible, we need to have an available FIAT stockpile. The portfolio begins with a 10% FIAT allocation, with plans to add to it with profits from trading and from altcoin gains. The NS can rest easy on this 10% allocation because, if cryptocurrencies in general go up, then there should be some pride in building a larger cash reserve. On the flip side, if the market turns down, then the cash reserve will be comparatively large and ripe for buying the dip.

FIAT allocation, which is completely absent from many NS portfolios, is central to this example portfolio, as well as any other similar portfolios. The trading and altcoin sections build up the FIAT pool, while the BTC (and sometimes ETH) pool is funded by it in dips. Furthermore, having cash readily available allows the NS to weather corrections with strong hands, as opposed to giving in to capitulation, because he or she can buy into the dips. In this way, the FIAT pool is both directly related to all other sections of the portfolio and central to the NS’ new portfolio management psychology.

Example Portfolio 2

We will analyze one more example portfolio before concluding. This portfolio is a hybrid between trading and long-term value investing. It employs portfolio management techniques to rationally capture value from “moonshot” micro-cap cryptocurrencies. Its general plan is as follows:

  • 15% BTC/ETH pool: Distributed across exchanges with hidden gems such as Kucoin, Gate.io, and Cryptopia. Most, if not all, is tied up in limit buy orders set at significant areas of support.
  • 40% Medium-cap holds: Projects that you really believe in, but that are too large to consider micro-cap. VEN, ICX, OMG, BNB, STEEM, and NANO are some likely candidates for this basket.
  • 30% Micro-cap moonshots: This allocation is aimed at unknown projects in their early stages of development, generally under 50 million dollars market capitalization. RVN, LUX, CFI, and OCN are reasonable examples.
  • 15% Temporary holds for roadmap updates and announcements: Buy the rumor, sell the news (50% of position at 100% profit).

This portfolio allows its creator to purchase a diverse basket of micro-cap moonshot coins, hoping that a few will eventually yield incredible 50x returns. Each micro-cap coin carries a very high risk to reward, so long as they are purchased early in their development, before any become well-known. For the medium-cap allocation, this can include projects that were bought on support after initial run-ups, or projects that were bought extremely low before they became noticed.

This portfolio requires little check-up, but conversely, a great deal of patience. Once a promising but unnoticed micro-cap coin is identified, the portfolio manager should use TA to identify a rock-bottom support (or places to which the coin price often wicks down to) and then place hopeful buy orders there. With such small coins, it is also particularly advisable to scale into these positions with dollar cost averaging. This strategy takes a good deal of BTC and ETH to be tied up in those limit-buy orders, so the portfolio plans for this accordingly. Once a coin is bought, all that remains is to set sell orders at high multipliers (or at prices for which the coin’s market cap would become reasonably large) and to keep lower buy orders ready to dollar cost average.

Because most of these coins are moonshots, it is not recommended to ever sell these coins except at the pre-set profit taking levels. There are many events in a coin’s history that might cause the coin to move parabolically, which might tempt the holder to sell pre-maturely. However, for these very long-term picks, more events will surely follow. The holder should also be aware of the great difficulty in timing profit taking on such small coins when they do move parabolically. As discussed in part one, selling out of long term positions can lead to lost potential profits, and worse, FOMO buys as the price continues to rise.

For portfolio managers that want to be more active, 15% of this example portfolio is held to be sold on relevant news for the coin (be it roadmap or surprise events). For these, a strategy of selling 50% of the position at 100% profit gives the holder a concrete plan to follow and allows profit taking without the risk of emotional decisions during monumental moves.

In this paper, we have covered the fundamentals of portfolio creation and management and reviewed two example portfolios. Having a planned and written-out portfolio is extremely important to promote rational decision making and to ward off excessive risk and emotional plays. In the next installment, Triage for the Losing Trader Part III: The Trading Plan, we will cover the psychology of trading plans, why they are necessary, and how to create one.

Contributed by Keaton Lee (@Keaton#5269).

If you liked the material here and you would like face-to-face help on Portfolio Management and creating a solid foundation with which to generate profits, you can purchase a one-on-one with the author here.

>>>Part I – Stop The Bleeding
>>>Part III – Coming Soon