The existence of momentum is a well-established empirical fact. The return premium is evident in 212 years of U.S. equity data (from 1801 to 2012) — as well as U.K. equity data dating back to the Victorian age in over 20 years of out-of-sample evidence from its original discovery, in 40 other countries and in more than a dozen other asset classes. Some of this evidence predates academic research in financial economics, suggesting that the momentum premium has been a part of markets for as long as there have been markets.
Since markets have existed, so has momentum, which results in constant uptrends and downtrends in asset prices. Changing price trends can result in wild swings in price, and for volatile assets, the fluctuations can be quick and violent.
Bitcoin is an attractive asset for trend followers because its uptrends tend to be very strong partly due to the inherent volatility of bitcoin. When bitcoin's price moves, it moves with force and bitcoin bull markets are notoriously fierce.
A simple trend-following strategy applied to bitcoin can potentially result in market-crushing returns if conditions are favorable. Using the 200-day exponential moving average, I constructed a bitcoin trading strategy: hold bitcoin when it trades above the 200-DMA, and hold cash when it trades below the 200-DMA.
After months of free fall, around 70% down from all-time highs, a sustained turnaround in Bitcoin's price in Spring 2019 indicated a changing sentiment in the market. When bitcoin broke above its 200-day moving average earlier this year, I saw it as a cue to go long. I sure didn't want to miss a chance at a potential bull market in the making.
Since then, bitcoin has substantially outperformed other asset classes, despite continued volatility. The breakout in April turned out to be very bullish for the cryptocurrency.
My investment thesis is intact- hold bitcoin as long as it stays above the 200-day exponential moving average. Based on this simple indicator, the uptrend is still in full swing. If the price were to fall tomorrow and blow past the 200-day exponential moving average, causing the position to get stopped out, this strategy would have yielded a nice profit.
Taking Profits Off The Table?
I kept the position size very conservative, as the entire position could quickly become worthless. Compromised exchanges, sudden loss of liquidity, or even harmful legislation could all potentially result in permanent impairment of capital.
For those who purchased bitcoin on the breakout and are sitting on profits, it could be tempting to cash out the position. While I understand the temptation, I will be sticking to my strategy and holding. I urged against taking profits earlier this summer after the initial stage of the most recent bull market, and I believe that advice still stands.
The "golden cross," one of the holy-grails of an uptrend, is when the 50-day moving average crosses above the 200-day moving average. In the article mentioned above, I said that the golden cross was potentially just days away from forming. When it eventually did, the price took off.
With the trend still in place, my strategy says to hold. For more conservative speculators, now could be the time to take out the initial investment and let the rest ride as "house money." Because the price has more than doubled, this is just "rebalancing" the portfolio to the original target allocation. There could be tax associated with the profitable sale of bitcoin depending on a taxpayer's jurisdiction.
Bitcoin's current uptrend is very much alive, and it could have a lot more room to run. Those looking to profit off of this uptrend should keep a watchful eye on their capital and size their positions appropriately.
Due to the sudden, violent changes in the price of bitcoin, profits have the potential to disappear in a moment's notice. While I will continue to hold bitcoin, I wouldn't fault those selling to trim down to their original allocation.
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.
Additional disclosure: As stated in the article, I own bitcoin.