Cryptocurrency investing: the importance of position sizing

In my previous post I explained the importance of diversification and position sizing when facing a volatile and unpredictable market.

When you are investing on the stock exchange there are thousands of well established companies and funds competing for your investment money, so diversification is pretty easy.

When you invest in cryptocurrency there are only a handful of established currencies to choose from. 

If we look at the usual definition of a large cap (> 10 billion dollars) only 3 currencies currently qualify: Bitcoin, Ripple & Etherum. If we look at medium caps (> 1 billion dollars) we can add Nem and Litecoin. To make diversification even harder most of those assets moves are correlated.

This means that when it comes to cryptocurrency investing your success will not depend so much on which currency you choose to trade in but mostly in position sizing.

Let's imagine that we are trading only one currency pair, USD & BTC, Starting with $1000 and whit an investment horizon of 1 year.

A BTC is worth round $2000 now, so if I invest all my money right away and the exchange rate climbs to $4000/BTC by the end of the year I have $2000 and  made $1000 profit. If the exchange has fallen to $1000/BTC I have lost $500.

Now lets imagine that I monitor the size of my position in the positive scenario ($4000/BTC at the end of the year):

I invest $800 at $2000/BTC, I have 400 mBTC and $200

The exchange rate increase to $3000/BTC. I sell 100 mBTC for $300. I now have 300 mBTC & $500

The exchange rate falls back to $1500/BTC. I invest $300 to buy 200 mBTC I have 500 mBTC and $200

The exchange rate increase to $3000/BTC. I sell 100 mBTC for $300. I now have 400 mBTC & $500

At end of year the exchange rate increase to $4000/BTC. I sell the remaining 400 mBTC for $1600. I now have $2100

End result: a profit of $1100 with properly sized positions vs $1000 for a buy-and-hold strategy.

Let's do the same exercise for the bad case scenario ($1000/BTC at the end of the year):

I invest $800 at $2000/BTC, I have 400 mBTC and $200

The exchange rate increase to $3000/BTC. I sell 100 mBTC for $300. I now have 300 mBTC & $500

The exchange rate falls back to $1500/BTC. I invest $300 to buy 200 mBTC I have 500 mBTC and $200

At end of year the exchange rate continue to fall to $1000/BTC. I sell the remaining 500 mBTC for $500. I now have $700

End result: a loss of $300 with properly sized positions vs $500 for a buy-and-hold strategy.

As you can see in the case of a volatile instrument like Bitcoins even adjusting position size by a mere 25% every few months can have a significant positive effect on the results after one year. 

When deciding how to size the position it is important to take into account:

• Your investing horizon. If you intend to hold for several years there is no point selling a large amount of your investment early in the game.
• The volatility of the cryptocurrency. If the value of your coin double or halves every 2 weeks you'll need to adjust more often than if the value double or halves every year.
• The cost of transaction. If you have a portfolio of only 100 mBCT and each transaction costs 5 mBCT you won't be able to modify your position size very often while remaining cost effective.

Good luck investing!

Image Creative Commons by Facundo Pramparo