Volatility in the Crypto Markets
10,000 hours of Preparation
Practice isn’t the thing you do once you’re good. It’s the thing you do that makes you good.” Said Malcolm Gladwell in his book Outliers.
In this book, Gladwell popularized the concept of the 10,000-hour rule. For those not familiar with this, the basic concept is that in order to become an expert in a field it requires 10,000 hours of practice.
Gladwell examines examples of this from the Beatles to Bill Gates. Gladwell found common themes in how their expertise was earned from countless hours of hard work and practice, not from inherit skill or luck.
Gladwell sums this up, “An extraordinarily consistent answer in an incredible number of fields … you need to have practiced, to have apprenticed, for 10,000 hours before you get good.” He asserts that even for the most dedicated these 10,000 hours usually takes ten years to achieve.
In my opinion, the crypto currency market didn’t even begin to resemble its current form until after the Ethereum ICO in 2014. So this 10,000 hours mark is not something many others or I can claim in the crypto currency markets, yet!
However, I believe the trademark of the crypto markets is their unprecedented volatility.
As an algorithmic futures trader, this level of volatility is nothing new to me. I have successfully navigated the financial crisis, a global cycle of quantitative easing, the flash crash, Brexit and many other extreme market events.
It is fair to to say after over a decade in the markets the only thing I am an expert at is markets moving against me, sleepless nights and accounting for risk that I am unable to control. I have become one of Gladwell’s experts in one of the least sexy ways possible. I am an expert at taking pain.
Despite the dry humor and self-deprecation, volatility and risk management are an integral part to the investing acumen I have built and a key component to our strategy at the CAOF.
This post will examine the volatility of the crypto currency markets, why it exists and how we use a sophisticated, disciplined model driven approach to harness it.
Just How Volatile is Volatile
Volatility in the United States stock market is tracked by the Volatility Index (VIX), also commonly referred to as the fear gauge. The VIX tracks the cost of insuring a portfolio of stocks against declines by using options as a hedge. Therefore, it tends to exhibit an inverse correlation to stocks. As stocks decline, the VIX rallies and often sharp, short term “volatile” drops in the stock market send the VIX soaring the fastest, as you can see in the chart below.
In the low interest rate environment we have found ourselves in since the financial crisis, the VIX has settled in the low to mid teens, and in times of short-term market turbulence and distribution, the VIX will spike into the 30’s and above.
Until recently, Crypto currency markets had no options to use to price this volatility in a similar manner. Ledger X, a NYC based CFTC regulated startup, was launched last October to create a Bitcoin options market and there are some OTC (over the counter) and overseas markets as well, all in their nascent stages. However, none of these markets offer us enough historical information for comparison here.
Instead we will examine the daily price fluctuations in the S&P 500 and Bitcoin over the last two years. The S&P 500 averages a daily move of just over .5% in that time period. Bitcoin, on the other hand, has a daily average move of over 2.5%.
Bitcoin is the gold standard best in breed of the cryptocurrency market, and due to this, it is the least volatile of all crypto currencies (with the exception of stable coins).
Ether, the second largest cryptocurrency by network value, has a daily volatility of over 4.3%, making it almost 75% more volatile than bitcoin, which is 500% more volatile than the S&P 500!
What this shows us is the inter-market volatility between different cryptocurrencies is greater than that of the entire stock market. This inter-market volatility creates a big opportunity for those who can embrace it!
Embracing this Volatility: 10,000 Hours in the Making
Originally in this post I had used the word harnessing instead of embracing in the above header. It dawned on me as I re-read that this was inaccurate. No one can truly harness volatility because no one can predict and control it. The best one can do is embrace and prepare for it.
Embracing volatility demands a disciplined systemic approach to the market. The CAOF uses “market uses cases” or sectors as a guiding principle to determine which cryptocurrencies to allocate to. Once these “uses cases” and coins have been selected, the desired and current weightings are standardized in terms of portfolio significance and divergences create trade signals. This model is how we embrace the extreme volatility to create opportunities but also to monitor exposure and risk.
The disciplined nature of our model driven portfolio allocation has provided the CAOF just this balance in the Fund’s first five months. And I am happy to report that in a very uncertain and pessimistic time frame for the broader cryptocurrency market, the CAOF has posted an estimated 15% gain as bitcoin has declined by 25%.
While it is a short sample size, I am pleased that my 10,000 hours in volatility management is helping the CAOF to successfully navigate a market with unprecedented volatility.
Published and written by Brandon Elsasser
Photo credits by dashforcenews.com