Cryptocurrency Trading Strategy — What Is It? (Backtest)

Last Updated on September 19, 2022 by Quantified Trading

The crypto market has been subject to high volatility which is one of the thrills that drive investors and traders alike. With high volatility comes substantial profit (and loss). Over the years, traders have tried and applied different strategies to increase their performance in the market. How can you make a cryptocurrency trading strategy?

A cryptocurrency strategy is the method and process traders and investors apply in the market to have a profitable edge. There is no suitable strategy for everyone, as each strategy is unique to the individual executing it.

In this post, we look at a cryptocurrency trading strategy and make a backtest with strict and mechanical trading rules.

Is there any strategy in cryptocurrency?

Due to the volatile nature of the crypto market, traders flock to the market looking for huge profits. However, many have lost more than they thought they would. The few who have been able to take home substantial profit owe their success to having a good strategy. With all the noise and news in the market, it’s easy to lose track of what is important and that is to execute your strategy properly without external influence (news and trading).

In the crypto world, a trading strategy is your guide to navigating the market. It is how you know when to buy and when to sell crypto so you don’t trade out of gut feelings. Some traders simply adapt what they have been using in the mainstream market like stocks, bonds, and the futures market.

Many have attempted using fundamental analysis, but that doesn’t seem to work so well in cryptos, as every project claims to render nearly the same services. Some focus on technical analysis using technical indicators, such as the RSI indicator, MACD, moving averages, or simply identifying chart patterns and other price action patterns.

There are also novice traders and investors that mostly base their buy and sell on the FUD and FOMO community (social media). They buy based on influential personalities’ recommendations about a particular project. For instance, the DogeCoin frenzy was fueled mainly by Elon Musk, CEO of Tesla (click here for a Dogecoin trading strategy). While some have been lucky and made good enough profits, others got on the bandwagon too late, only to realize they have been dumped on.

By and large, crypto strategies are individualized, so you must find what works for you and stick to it. We always prefer quantified strategies but you must realize that the crypto market changes a lot, so be ready to keep tweaking your strategy or switching to a new one.

How do you make a crypto trading strategy?

To develop a trading strategy, you must have done some basic homework.

First of all, you have to know that there are more than ten thousand crypto coins out there. That alone is enough to blow your mind. It is unwise to begin trading every coin you see. You must choose from the top 10 coins if you want to trade based on technical trading indicators. Don’t trade shitcoins unless you just want to throw in some money and hope for the best. Additionally, volatility is not the same for all coins. Bitcoin behaves differently from Ethereum even though they tend to trade in the same direction most of the time.

To create a strategy, you must have some written goals and trading rules to follow (and each rule can have many settings). There is no one cut fits all in this and copying others might not be ideal. Picking a goal goes beyond stating that you want to make an X amount in X days or months.

Below are some steps to follow when developing a strategy:

  • Choose an approach. The first step in your crypto journey is to determine what you want to do. Do you want to trade or invest? While they may sound similar, the difference between the two has to do with the frequency of trading and the duration of each trade (please read our guide to trade or invest?). Traders simply take advantage of the daily fluctuation of price while investors buy and hold for medium to long-term gains. Your desired path is solely dependent on your objectives or goals as well as your risk appetite.

  • Narrow down assets to trade or invest. The problem with traders and investors, in general, is having their hands on too many cryptocurrencies at a time. While this may not seem like a problem, the common sense here is to focus only on a few coins. In doing so, you can have maximum time to research and backtest strategy without feeling overloaded with too much information. Besides, most of the coins tend to move together, and investing or trading in so many assets at once won’t diversify your risks that much.

  • Choose a method. A trading method can be using indicators, price action, or fundamentals to take a position in the market. Make sure to practice the method on your preferred choice of an asset to ensure it is working. Some traders use a combination of technical and fundamental analysis to better gauge the market sentiments while others simply focus on one.

  • Determine your entry and exit rules. You need to know when to enter and exit the market based on your trading strategy. For example, it can be a moving average crossover, oversold/overbought levels, or the first negative or positive tweet you see in the crypto community.

  • Back-test and forward-test your method. To determine the accuracy of your trading system and trading rules, you need to backtest it on historical prices to see how it would have fared. If it performed well, you forward-test by paper-trading on a live market basis to see if it can still be applied to current market conditions. Remember that taking your time to master a given strategy is better than jumping on the bandwagon ill-prepared and losing your investment capital.

Which crypto to make strategy?

As stated before, volatility varies among different coins, and studying them subjectively will help you from avoiding losses. For example, Bitcoin’s daily price fluctuation can be around 1-5%, whereas other small-cap coins like PERP might have a daily percentage gain of up to 10% and more. This might be suitable with a high-risk tolerance but swings such as this are sufficient enough to go get you stopped out of a trade.

A crypto-specific trading strategy might be best if you are trading different coins at a go. For example, you might decide to scalp PERP and swing trade ETH. Since the price of ETH is more stable than PERP, it will be okay to hold it for a few days without worrying about getting stopped out due to daily price fluctuations.

Cryptocurrency strategy for beginners

As a beginner, you must find a strategy that suits your personality and circumstances. Having said that, here are different strategies used by crypto traders:

Scalping

Scalping has become a popular strategy in the crypto market. This strategy takes advantage of the little price fluctuation at frequent intervals. The high volatility in the crypto market has made scalping a suitable strategy since there are many opportunities for quick profits. Scalping aims to build on small profits over a long time. However, developing a scalping trading strategy is very difficult and requires lots of volatility.

Scalpers open multiple positions in smaller time frames such as 1 minute, 5 minutes, and 15 minutes, and trades are opened and closed frequently with the use of tight stops. They may use leverage to maximize profits. Scalping is not suitable for all traders since it carries a high risk and can have a significant effect on your emotions.

Day trading

Day trading involves entering and exiting positions within a single day. Compared to scalping, this strategy is less risky and you don’t have to enter trades frequently at intervals. Your aim as a day trader is to capitalize on the intraday price movement of assets.

Traders in this category normally use a higher timeframe like the 15 minutes, 30 minutes, and hourly timeframes for entry and exits. Most of the day trading strategies rely on technical analysis.

Swing trading

As a swing trader, your main aim is to capitalize on price swings spanning days and even up to a week or more. It is a medium-term trading strategy since it is a bit of a day trading and position trading strategy. As a result, it gives you more time to consider your trading decisions which means less room for error while eliminating emotional trading. A swing trading strategy is more suitable for beginners because of the lower risk associated with it.

Position trading or trend following

Position trading gives you the liberty of holding your trades for a longer period. Short-term price swings are not considered in this strategy, as your focus is more on the longer-term trend. Fundamental analysis is the major decision-making factor here, but some traders can use both fundamental and technical analysis to fine-tune their entry. Trades are helpful for weeks, months, and in some cases years.

Most profitable crypto trading strategy

There is no one-size-cut-all trading strategy but some trading strategies have a higher performance than others. How well you follow trading strategies is also a big factor in how profitable it can be.

Also, how you manage risks can have a significant impact on your profit factor. Traders who use tight stops may be subject to a series of losses compared to those that use wide stops(read here for the pros and cons of stop loss). Although wide stops can save you from incessant knockouts from trades, they can also leave you with large losses enough to blow your account. So, you need a well-calculated risk management method. Using the 2% rule might be profitable and ensure you sustain your account in periods of losing streaks.

By and large, medium to long-term trading seems to be more profitable than short-term trading. Short-term trading always puts the trader on the edge, which might give room for errors.

Cryptocurrency trading strategy (backtest and example)

Bitcoin is still a relatively new asset class and we can safely say it has become more and more “mainstream” after the first boom and bust cycle from 2016 to 2018. Even famous traders and investors like Paul Tudor Jones and Ray Dalio have invested in Bitcoin.

However, because cryptocurrencies are a relatively new asset class, the data is limited for proper backtesting, in our opinion.

That said, Bitcoin has been a good vehicle for trading because of the volatility and its powerful trends either up or down, must up since its inception, though. Below is a chart showing the ups and down of Bitcoin:

Cryptocurrecy trading strategy (Bitcoin price chart)
Cryptocurrecy trading strategy (Bitcoin price chart)

Keep in mind that the chart above has a logarithmic scale – the only correct visual display of time series over many years or assets with huge volatility (what is log scale chart?)

The same trading strategies that work on stocks are much less likely to work on Bitcoin or any other cryptocurrency. This is to be expected. Cryptocurrencies are different assets than stocks (or bonds and commodities for that matter) and you can’t expect the same strategies to work on both.

So far, cryptocurrencies have worked well as trend following strategies and less well on mean reversion strategies. Is this likely to continue? We suspect cryptocurrencies will gradually lose some of their trend-following abilities as it continues to become more and more mainstream. It has worked as a “risk on, risk off” asset, but just with a lot more volatility than many of the other risky assets.

Let’s go on to backtest a couple of cryptocurrency trading strategies:

Cryptocurrency trading strategy no 1

Let’s jump to our first crypto strategy. The trading strategy reads like this in plain English:

  1. Buy at the close if the close breaks above the 20-day simple moving average.
  2. Sell at the close if the close breaks below the 20-day simple moving average.

This is as simple as it gets. How has the strategy performed?

Below is the equity curve (what is a good equity curve?):

Cryptocurrency trading strategy no 1
Cryptocurrency trading strategy no 1

This simple strategy has beaten buy and hold with a wide margin despite being invested only 50% of the time: 95% vs 64%.

Is the result curve fitted? (read here for what is curve fitting?) No, it works well for many different days in the moving average.

Along the way, you have to suffer some pretty gut-wrenching drawdowns of 66%, but still smaller than the buy and hold drawdown of 84%. Because this is more or less a trend following strategy it has partially a tail risk hedge.  The reason why can be seen in the chart below that shows the annual returns and the profit distribution:

Cryptocurrency trading strategy (profit distribution)
Cryptocurrency trading strategy (profit distribution)

The strategy has many more big gains than big losses – it’s the opposite of a negatively skewed distribution.

Can we expect Bitcoin and cryptocurrencies to show the same attributes in the future? We don’t think so. As the asset class matures we expect it to become more like any mean reversion strategy.

Cryptocurrency trading strategy no 2

Let’s go on to backtest a classical moving average crossover strategy. Such strategies normally do well for trending assets and those that have high volatility. Originally our plan was to use a 100-day and 250-day moving average, but it’s very few trades (even though the results are great). So we simply removed one zero from the moving averages.

The moving average crossover strategy has the following trading rules and settings in plain English:

  • When the 10-day moving average crosses above the 25-day moving average, we go long at the close.
  • When the 10-day moving average crosses below the 25-day moving average, we sell at the close.

Let’s backtest the strategy on the other main cryptocurrency: Ethereum. The trading strategy’s equity curve looks like this:

Cryptocurrency trading strategy (Etherum moving average crossover system)
Cryptocurrency trading strategy (Ethereum moving average crossover system)

The strategy has performed better than buy and hold: 94% annual returns vs 42% over 31 trades. The win rate is rather low at 54% but it’s total profits that matter (read here for win rate in trading). In case you wondered why we always present an equity curve and not more numbers we recommend reading our trading strategy performance guide or money, risk, strategy management guide.

Let’s also backtest the main cryptocurrency: Bitcoin. This is what the equity curve looks like:

Cryptocurrency trading strategy (Bitcoin moving average crossover system)
Cryptocurrency trading strategy (Bitcoin moving average crossover system)

Again, our cryptocurrency trading system beats the buy and hold: 91% vs 64%. However, we are confident most traders would have abandoned the strategy along the way. Why? Because they can’t stomach the drawdowns. At the end of the day, most traders are their own worst enemies.

Is the strategy curve fitted? We don’t know, but let’s go on to make a strategy optimization (how to optimize a trading strategy). We changed the number of days in the moving averages to the following:

  • The short moving average has values from 10 to 50 days with 10-day intervals.
  • The long moving average has values from 20 to 100 days with 10-day intervals.

There are 45 backtests involved in this strategy optimization (we backtest on Bitcoin). The results are summarized in the table below:

Cryptocurrency trading strategy (optimization)
Cryptocurrency trading strategy (optimization)

The results are ranked based on the profit factor (what is a good profit factor?). As you can see from columns 1 and 2 is that the best strategy settings are with a relatively short moving average (10-30 days) and a long moving average (60-100 days). The majority of the systems beat buy and hold.

Crypto trading strategies and Amibroker

The backtests done in this post are published together with the Amibroker code for over 100 other free profitable trading strategies. Some of them have Tradestation/Easy Language code as well. You can find this product on this link:

Also, we have many other trading strategies and edges that we publish for our subscribers. Please check out our shop:

Cryptocurrency trading strategy – ending remarks

The cryptocurrency trading strategy presented in this post has hopefully given you some trading ideas.

That said, we expect the cryptocurrency market to evolve a lot over the coming years. We suspect one of the main changes will be a gradual shift to mean reversion strategies from trend-following strategies. Also, if cryptocurrency trading strategies get more mainstream, we expect volatility to come down.

Similar Posts