An Approach With Less Risk?
Playing It Safe With Cryptos
Cryptocurrency trading carries various kinds of risks.
Here, we’ll compare several trading methods to nd
out which could have less risk when approaching the
cryptocurrency markets.
by Perry J. Kaufman
say that cryptocurrencies are “popu-
lar” nowadays would be an under-
statement, and the 6,700 cryptocur-
rencies currently available make it
clear that just about everyone is in
the game.
There are two key areas to focus
on when thinking about trading cryptos: First, which
are safest, and second, how do you trade them without
exposing yourself to extreme risk?
18 • August 2021 • Technical Analysis of STOCKS & COMMODITIES
AN OVERVIEW OF CRYPTO RISK
There has been a lot written about cryptocurrencies, so
I won’t belabor it here. The biggest issue is counterparty
risk, that is, are your trades guaranteed? If you trade bit-
coin (BTC) on the CME (formerly known as the Chicago
Mercantile Exchange), all your trades are backed by the
clearing house. That is some comfort.
BULLS AND BEARS: LIGHT SPRING/GOLD BITCOIN: FLOWERS AND
But what happens if something goes wrong with a
TROLLING/SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON
trade in bitcoin or Dogecoin? What if you get a bad ll,
or worse, your account is hacked and money disappears?
As far as we know, you are out of luck. There are no
guarantees.
Even though Ethereum (ETH) and Coinbase (COIN)
are listed on exchanges, it does not guarantee that those
companies will survive. When Enron collapsed in the late
1990s, investors lost everything. The NYSE and CME
guarantee that the trades are accounted for correctly, but
 CRYPTOCURRENCY TRADING
MICROSOFT EXCEL

FIGURE 1: EURUSD (CASH) VOLATILITY. The volatility of the euro versus

the US dollar based on a 20-day annualized volatility calculation clusters
mostly in the range of +/-1%.

they do not guarantee the company’s existence.

That is an example counterparty risk. So be sure to do
your homework. Caveat emptor.

VOLATILITY
The next important feature of cryptos is their volatility.
Cryptos put themselves forward as a pseudo-currency.
But a sovereign currency is backed by a combination of
the country’s treasury and gross national product, that
is, the products that the country produces and trades
with other countries.
When Germany wants to buy wheat from the US, it
rst converts the cost of the purchase from euros into US
dollars. That strengthens the dollar. When the US imports
goods from China, it buys yuan, which strengthens the
Chinese currency and weakens the US dollar.
None of that exists in cryptocurrencies. Their value
depends only on supply and demand. It has no intrinsic
value. In all fairness, gold has many similarities, although
it has a history of thousands of years.
Without an intrinsic value, crypto prices can vary
wildly. For example, Figure 1 shows the volatility of
the euro (versus the US dollar) based on a 20-day an-
nualized volatility calculation. It clusters mostly in the
range of +/-1%.
Now look at a chart of cryptocurrencies bitcoin (BTC-
USD) and Dogecoin (DOGE-USD) (Figure 2). BTC is
erratic but clusters between about +7% and -7%. DOGE
is more dif cult to read, but what is clear are the spikes
to 50% around 2017 and higher recently. Volatility is
risk. It’s nice when it goes your way but disastrous when
it goes the wrong way.
In order to begin a relatively safe trade, we need to bring
down the volatility to a reasonable level. If we annualize
the volatility of the euro from 1999 to now, we get a value
of 9.53% with an average of near zero. That means there
FIGURE 2: BITCOIN VOLATILITY (TOP), DOGECOIN VOLATILITY (BOT-
TOM). Cryptocurrency prices can vary wildly. BTC is erratic but clusters
between about +7% and -7%. In DOGE, you can see spikes to 50% and
higher. Compare this to the volatility seen in Figure 1 of EURUSD.
is a 16% chance of a drawdown of more than 9.53% and
a 2.5% chance of losing more than 19%.
Compare that with bitcoin since it started trading in
2014. Its average 20-day volatility is 61.5%. That means
there is a 16% chance of losing 61.5% and a 2.5% chance
of losing 123%. That is high risk, but not compared to
DOGE. The annualized volatility of DOGE is 145%!
If you want to trade bitcoin safely, you need to reduce
your exposure to that of the euro (9.53/61.5 = 0.15).
Then you should be trading only 15% of your normal
exposure. For DOGE we get 9.53/145 = 0.065 or 6.5%
of your normal risk. That way it matches the risk of the
rest of your portfolio.
The 6,700 cryptocurrencies
currently available make
it clear that just about
everyone is in the game.
August 2021 • Technical Analysis of STOCKS & COMMODITIES • 19
 TRADING A VOLATILE CRYPTOCURRENCY
Now let’s look at the ways we can trade cryptos. Do we
go for the long-term position or choose fast trading? A
long-term position in a market that is volatile means
holding a trade through severe ups and downs. Figure 3
shows the results of a moving average optimization of
Ethereum (ETH) using the following rules:

• Buy when the price crosses above the moving

average
• Sell short when the price crosses below the mov-
FIGURE 3: TOTAL PROFITS FOR LONG AND SHORT TRADES, ETHERE- ing average
UM, FROM 2015. The best result in the test used a 120-day moving average,
gaining over $8 million on a $10,000 investment beginning in 2015. The total pro ts of both long and short positions are
shown in Figure 3. The shorts
are dif cult to see, leaving us
with the conclusion that we
only want to take long trades.
And those trades are very
pro table. The best result used
a 120-day moving average,
gaining over $8 million on a
$10,000 investment beginning
in 2015. A remarkable return.
Figure 4 is a chart of ETH.
Using the 120-day moving av-
erage, the last trade was entered
in mid-April 2020 at 172.12
and held until mid-May 2021,
exiting at 3282.40 for a gain of
TRADESTATION

1,807%. Not bad.

FIGURE 4: ETHEREUM TRADES USING A 120-DAY MOVING AVERAGE. Using the 120-day moving aver-
But the other side of this
age, the last trade in the test was entered in mid-April 2020 at 172.12 and held until mid-May 2021, exiting at pro t is the risk. In order to
3282.40 for a gain of 1,807%. Clearly, the profit potential in a volatile market such as this can be huge, but hold ETH for more than a year,
holding a long-term position in a volatile market means holding a trade through severe ups and downs. you need to steel yourself to
the drawdown. In February the
price fell from about 2,000 to 1,400, a loss of 30%. Had
you been trading from 2014 that would be nothing, but
if you entered at 1,000 or higher, it would have taken
away most of your gains.
Figure 5 shows the maximum intraday drawdown for
each calculation period. While the largest drawdown
occurred in March 2020, it was $40,000, four times
larger than our investment of $10,000. If you had not
accumulated large pro ts by then, your trading activ-
ity would be forced into retirement. No matter which
calculation period you choose, a trend system posted a
FIGURE 5: MAXIMUM DRAWDOWNS ASSOCIATED WITH EACH MOVING large drawdown.
AVERAGE. Here you can see the maximum intraday drawdown for each
Even Elon Musk has shown he is not willing to hold a
calculation period of the tested moving averages. The largest drawdown
occurred in March 2020 and was four times larger than the initial invest- crypto trade for very long. You might think of a crypto
ment of $10,000 in the test. trade as more of a trading event than an investment.
20 • August 2021 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 6: AN OPTIMIZATION OF BTC VOLATILITY EXIT WITH A
FIXED RESET OF A 30% DECLINE IN VOLATILITY. The best result in
the test was an exit when the volatility was at 440%, but that value would
have made you miss a large upward move. If we fix the reset as a decline
of at least 30% in volatility, we get the results seen here.
TRADING A FASTER METHOD
A strategy that can be successful in more volatile markets
is buying a pullback in an uptrend. You may miss a part of
the big move, but you have a better chance of controlling
the risk. We could also use a moving average crossover,
where we trade in the direction of the slow trend but only
when the fast trend con rms that direction. For a long-
only system, both trends would need to be up, or the fast
trend would need to be above the slow trend.
I tested ETH using the crossover method, trying to
capture smaller upward moves and avoid the drawdowns.
An optimization showed that the best combination was
a 100-day slow moving average and a 4-day fast mov-
ing average. Returns were excellent but there was a 70%
drawdown. That did not seem acceptable.
When we look at the chart of bitcoin (BTC-USD), it is
clear that the gains are made in the big moves up. Short
sales are unlikely to work, and waiting for a pullback will
miss most of the pro ts. What other choice is there?
EXITING ON EXTREME VOLATILITY
High volatility means high risk, and high volatility is
dif cult to sustain. One of the few rules that works for
long-term trends is to exit when volatility gets extreme.
You can wait for a new trading signal or reset the position
when volatility drops by some preset amount. A drop in
volatility usually means a return to normal.
We’ll measure volatility in the normal way, that is,
the standard deviation of the returns of the past 20 days
multiplied by the square root of 252.
For most stocks, extreme volatility is around 90% to
100%, based on this 20-day annualized volatility measure.
But cryptos are much more volatile—as we saw earlier, 7
to 10 times as volatile. Perhaps, as cryptos mature, those
FIGURE 7: COMPARING TWO DIFFERENT VOLATILITY EXIT FACTORS,
BTC. Ideally, a volatility exit factor will capture more than one trade. While
using an 80-day moving average and a reset of 30%, the results of two
extreme volatility exits, 4.4 and 2.5, can be compared.
levels will decline, but that time has not yet come.
I tested BTC-USD rst for the best moving average and
found it was 80 days, typical of a macrotrend system. I
then tested an extreme volatility exit and reset. The best
was an exit when the volatility was at 440%. As you can
imagine, that value picked off the top of an upwards
move. If we x the reset as a decline of at least 30% in
volatility, we get the results in Figure 6.
As you can see, there is a pro t spike at volatility
factor 4.4. I think that is unrealistic. There is not much
history for cryptos, and we would like a volatility exit
factor that captures more than one trade. With that in
mind, I tested a 2.5 pro t factor, the center of a at area
in Figure 6. Results of the 4.4 and 2.5 factors are shown
in Figure 7.
While we all want to get as much pro t as possible,
missing an extreme volatility exit could result in a large
drawdown. Figure 7 shows that the pro ts ofbothvolatility
factors have been the same since October 2017. The table
in Figure 8 compares the pro le of the two methods.
Although the exit factor of 2.5 reduces returns by 28%,
it reduces the drawdown by the same percentage. The
2.5 factor is likely to trigger more exits, so that is going
to be a better choice than capturing a single extreme
move—one that may never happen again.
One of the few rules that
works for long-term trends
is to exit when volatility
gets extreme.
August 2021 • Technical Analysis of STOCKS & COMMODITIES • 21
 Extreme Volatility Exit 4.4 Extreme Volatility Exit 2.5
All Trades Long Trades Short Trades All Trades Long Trades Short Trades
Total Net Profit $160,333 $155,210 $5,123 $115,114 $109,991 $5,123
Profit Factor 16.03 28.43 2.02 9.84 14.72 2.02

Total Number of Trades 59 31 28 61 33 28

Percent Profitable 55.93% 70.97% 39.29% 55.74% 69.70% 39.29%
Winning Trades 33 22 11 34 23 11
Losing Trades 26 9 17 27 10 17

Even Trades 0 0 0 0 0 0
Avg. Trade Net Profit $2,718 $5,007 $183 $1,887 $3,333 $183
Max. Consecutive Winning Trades 6 5 3 6 5 3
Max. Consecutive Losing Trades 3 3 7 3 3 7

Avg. Bars in Total Trades 24.37 32.42 15.46 22.64 28.73 15.46
Annual Rate of Return 16.98% 13.59%
Max Drawdown ($16,009) ($16,009) ($4,923) ($11,397) ($11,397) ($4,923)
Date 7/17/2017 1/11/2021

as % of Initial Capital 16.01% 16.01% 4.92% 11.40% 11.40% 4.92%

FIGURE 8: COMPARING TWO DIFFERENT VOLATILITY EXIT FACTORS, BTC. This table compares the two methods from Figure 7, which are
based on the two volatility exit factors described.

CHOOSING SAFETY
This has been a quick look at some possible ways to trade
cryptocurrencies. The main concern with these markets
is volatility. A moving average generates large pro ts
but at great risk. By taking off trades that are at extreme
volatility levels, you can capture pro ts and reduce your
exposure at a critical time. Waiting for a small drop in
volatility before reentering gives you a chance to add
more pro ts without the extreme risk.
The cryptocurrency markets tend to have strong trends,
and trading in the direction of the trend is always the
safer approach. The 80-day moving average is typical
of a macrotrend system, which in my experience has
proved reliable for many years. Limiting the rules to the
trend and volatility exit is a simple solution, better than
These markets have a
strong trend and trading in
the direction of the trend
is the safer approach.
trying to over t pro t-taking levels, trailing stops, and
various patterns. But volatility will change over time, so
keep monitoring it.
Perry J. Kaufman is a trader and nancial engineer. He is
the author of many books on trading and market analysis,
including the sixth edition (2020) of Trading Systems
and Methods (with the rst edition published in 1978 as
a seminal book in the eld of technical analysis), and
the most recent, Kaufman Constructs Trading Systems
(2020). For questions or comments, please go to www.
kaufmansignals.com.
FURTHER READING
Kaufman, Perry J. [2020]. Kaufman Constructs Trading
Systems (print and ebook editions), Amazon.
[2020]. Trading Systems and Methods, 6th Edi-
tion, Wiley.
[1995]. Smarter Trading, McGraw-Hill.

22 • August 2021 • Technical Analysis of STOCKS & COMMODITIES