An alternative algorithmic approach to alternative investment

Emotion-Technical factor approach on bitcoin

I. Introduction

“Do not get close to crypto or any asset you do not know much about!”, people say. Indeed,
Bitcoin presents us with a mysterious vibe, in terms of volatility or any other economic
terms. However, revealing the unknown, there is advantage in bitcoin investing. I hereby
present an algorithmic approach, meaning investment decision based on a Random Forest
Algorithm, to bitcoin investing.

The idea is based on empirical evidence I made during my internship as a Quant research
team, as well as theoretical knowledge gained in FINA3325, blockchain part specifically. I
will answer all the required question specifically in the following part.

II. Background Knowledge

Bitcoin, one specification in Cryptocurrency asset class. Together with bitcoin (BTC), there
are also famous crypto invented like ether (ETH), bitcoin cash (BCH) and Litecoin (LTC). Just
to be clear, our investment target will only be Bitcoin, but we will use the historical
information of ETH, BCH and LTC in decision making. We shall illustrate later.

III. Why BTC?

To answer it, it helps to investigate the main investor and its historical performance.

Main investor: The current existence of BTC amounts to 19224406.25. By a simple search,
we could see that the main possessor of bitcoin is Satoshi Nakamoto of around 1.1 million
BTC, Winklevoss Twins of 70000 BTC, Tim Draper, a famous VC founder, of 29000+ BTC and
so on. We could see that the main players in BTC trading dominates a large position in the
whole pool. Nowadays with most Bitcoin trading in Crypto Exchange, the price of bitcoin is
highly determined by force of buying power/selling power. From knowledge in
Demand/Supply and Micro-Market-Structure, we know that people with most bitcoin can
easily drive the price in their favorable direction, as recorded many times earlier. More into
it, are the above data listed indeed the real picture? Not necessarily, though bitcoin itself is
traceable, people could put their bitcoin in different address. So, it’s not hard to tell that the
main force in BTC is only stronger than listed.

Historical performance: BTC price movement is of high volatility! Although the 30-Day
volatility has been dropping down since its release in 2009, they still have round 3%! (See
figure 1). It would be more apparent if we compare it to Apple Shares which is also
sometimes volatile: Apple has 30-day volatility of 0.3% in average. In terms of price, BTC are
now at a position of 17,000, around 120 times higher than Apple. All in all, BTC are of high
historical mean price and volatility. Upon research and deduction, the high volatility is
correlating with the fact that main player hold too big a portion of all BTC, and the “Impact
of social media” (release of news causing dramatic price movement in BTC)!
Reason for investment: Upon looking at this interconnected fact, it provides clues on why
BTC would be a good investment target: It provides constant up-and-down price
movement and at the same times, showing patterns that modern machine learning
algorithm could capture! it would be a good asset to conduct day-frequent trading
Investment.

IV. Specific Investment approach

In general, an algorithmic approach I have personally conducted for three months, It

roughly involves four stages. 1. Constructing Model 2. Collect historical data 3. Train your
model 4. Make prediction. Upon training the model, we give it the most recent information
we had for every 2 hours, it generates a suggested long/short position for us to take until
the next round (For article length limit, I will go through in a quickest way). Specifically, we
notice that BTC price changes drastically according to social media information release. For
example, when Elon Musk post on twitter that he publicly roots for Doggie Coin, the coin
price goes up by 80% in its peak. It leads to the following technical factor + emotional factor
prediction method.

Implementation using NLP: That is, besides the technical factor like Moving Average
Convergence/Divergence or Relative Strength Index and others, we would like to add in
emotional factor using NLP technology (see figure 2). Specifically, we need to train the
model using past text scrapped from major social media like twitter and Meta, and let the
model understand the logic between text people posted and the preferred trading direction
they conveyed. The model will then generate prediction based on both Tech and Emotional
factor.

Investment Strategy Development Procedure: Combined what I empirically get using

python-pandas and TensorFlow framework, the procedure could be described as,
1. Constructed a Random Forest Classifier (See figure 3) which is a good choice for taking
information and generating a number indicating corresponding class (long/short position)
2. Collect historical data, use Talib to construct technical factor (See figure 4) and using
regular expression to construct emotional factor
3. Use the factor and train the model. (For illustration purpose I skip the validation set).
4. Use the trained model to generate real-time output (long/short exposure) and make
investment.

V. Investment logistic

Investment Horizon and capital input: The whole investment horizon would be one year.
We trade every two hours when model generates output. We update the model every two
months. I will personally put 20% of overall asset into it and constantly evaluating. The
reason I think these parameters make sense is because:
1. Bitcoin will only be exhausted till 2140. Before then, if we could choose and constantly
update choice on a good crypto exchange, it is worth a long-term investment horizon.
2. We need to constantly update our model because the logic encoded in the model may fall
behind the logic in the current market. The way to update is by doing the procedure above.
3. I think 20% of overall asset for BTC is a reasonable choice, First, Blockchain technology
ensures that it is a relatively stable asset class. Secondly, it also shouldn’t take up more
capital since they should be invested in more major categories to ensure benchmark
performance. At last, 20% of overall asset would save up place for hedging need.

VI. Conclusion

Bitcoin, a by-product of blockchain technology. Many people avoid it for high volatility,
short-lasting trend, and high sensitivity to public emotion. Leveraging these characteristics,
we proposed a Tech+Emotional factor machine learning model to predict short term price
movement. We analyzed the major investor, historical performance to validate the reason.
Also, certain investment logistics are proposed with reasons listed above.

Many people argued with “51% computing power dilemma” or “the bankrupt of FTX”, but
we need not let one new to disqualify the strength inside blockchain technology. Let alone
hour-frequent trading neatly avoid these drawbacks. It would be a good alternative
investment choice. I see good future in it.

VII. Appendix

figure 1

figure 2

figure 3
figure 4