Since our last alert, the giant price surge on March 17th has shifted the strategy into our green environment. So, I think it's time to do a recap of the red zone and introduce the green one and what to expect from it.
Red environment recap:
The initial idea behind the red environment was to flag a zone at the end of a downtrend where we should see the bottoming price. Why separate this zone from our yellow environment that is designed for navigating a strong downtrend? The main reason lies in the associated risk. In a cyclical downtrend, the risk is being long Bitcoin. So, our yellow environment will tend to be mostly out or short Bitcoin, going in only for the powerful bear market rallies, but will quickly exit if the weather turns. In fact, for most of our yellow zone, you can expect us to be short instead of simply out.
In the red zone, although we are still in the cyclical downtrend for most of it, the risk shifts to not being in Bitcoin. In fact, a buy on the first day that we switch to the red environment usually ends up in profit the day we switch back to a green environment if we never sell again during this zone. The very first version of our strategy was actually almost only doing that in this zone, trying to buy an outlier statistic on one of our metrics and stay in for the rest of the bear market. Along the road, we decided to add the modality to our red environment to also sell to protect us in case of a further drawdown and also to capture the alpha of this very volatile environment. But the main idea remains: not missing the opportunity of buying in the abyss while staying defensive. These two goals that are sometimes in conflict generate an environment that will see more trading. In fact, including this BTC cycle, we have been in that zone for 18.5% of the time since October 18th, 2011, but this zone has seen 39% of the trades, which is more than twice its share of time in trades. The average amount of time spent in that zone for each cycle was 189 days if we exclude the very quick COVID drop. We have been in that zone for more than 276 days this time, which is 46% longer than the average and just 14 bar shorter than the longest one in Bitcoin history (2015 Bottom).
For this cycle, we entered that zone on June 13th, 2022, and had the first trades on June 18th, 2022. Although WealthUmbrella didn't take that trade live (strategy was in development), we actually followed it when we saw a similar price on July 12th, 2022. All the other trades have been live trades for us. In total, we had 5 pairs of trades (buy and sell).
1.Buy on June 18th 2022 – Sell on August 19th
2.Buy on November 18th 2022 – Sell on December 19th
3. Buy on January 4th 2023 – Sell on February 11th 2023
4. Buy on February 15th 2023 –Sell on March 4th 2023
5. Buy on March 16th – Close this Zone at the end of the day on March 17th 2023
The buy-and-hold return if we would have bought on the first day we switched to the red zone would be around 22.1% when we exited that zone. As we said above, we expected that the buy-and-hold return in that zone would be positive since this zone is actually designed to flag the place where the bottom should appear. The yellow zone will actually see the opposite with a highly negative buy-and-hold value for an expected strongly positive strategy return. Nevertheless, the strategy return managed to land a good 41.56%, which is almost 100% more than buy and hold on the day we entered the red zone while protecting us from being in during most of the drops of that though time. The strategy had a 60% winning rate, which is lower than the historical performance that sits at 80% but that is almost in line with our success rate in the red zone (68%). That being said, with only 5 pairs of trades, this data is to be taken with a grain of salt since one more winning trade would have meant a success rate of 80%, and one less, 40%. Out of the two trades that were losers, one was almost neutral with a loss of -1.44% (For comparison the biggest run we had was 29.5%), while the other one (the one closed on March 4th) stacked a loss of -8.14%. But, If we have to learn one thing from this past cyclical red zone to improve our strategy, this is related to that trade.
Lesson learn and Improvement
We separated our strategy into 4 different modes that we distinguished by color because we realized that the different phases of each Bitcoin cycle required a different behavior. In the red zone, not only is the risk not being in Bitcoin, but we also usually have plenty of time at the bottom to buy and sell. There is no instant recovery around the bottom, as we can see by the 3 trades between November and January on this image:
In the green environment, we don't see the same thing. When we see a small dip, since the underlying narrative is bullish, most of the time it's going to recover in very few days, as we can see in this image from 2020:
It has then become very hard to go out and back in at a profit since you always need to see some red before deciding that the trend is down and need to see some green to decide that the bullish trend is back.
The issue with this is that we divided these zones with a binary threshold. This threshold was correct in the previous cycle since most of the time we had a very simple push out of the red zone. As I said above, this past red phase was one of the longest ever but was clearly the one with the most drama around it. In fact, it's the first time in its history that Bitcoin saw a real stock bear market at the same time, resulting in a more bumpy road.
The last trades happened a few days after the price made a push just 1% under the threshold to switch into the green environment. Despite still being in the red zone, the reality in the field for investors was that the sentiment and economic situation were more nuanced and positive at that level (26K$) than it was around 15k$, and the strategy should have taken that into account since we were actually closer of the green zone market behavior. Indeed, on March 4th, it's not that the strategy didn't flag well that we were going to see some drawdown. We indeed had a 12.65% move down after we went out of BTC and we were probably all happy to being out while there was the drama around SVB and the USDC depegging but the recovery was simply too fast with two major green candles for our strategy that is very restrictive at buying in the red zone.
So what will we do in the future? Although we will keep our binary approach to the change of environment, we will make the Ehler Filter threshold (the tool we used to be defensive in the red zone) variable as a function of how close we are to switching to the green. This will make our strategy less sensitive to selling and more sensitive to buyback as we approach the exit of the red zone, something that will be a more natural transition toward more passive behavior associated with the green zone. This change will be backtested and introduced in a further version of the strategy. This is not our priority at this moment since we are out of that zone, and unless the market gives us the catalyst to go back in that zone like COVID did in 2020, we should only see the red environment coming back in a few years from now. Our focus now is on protecting against a market downturn in the green environment, selling any overbought conditions based on on-chain metrics, and successfully moving towards our blue environment where we should be able to see the next major top coming. Rest assured that this improvement will be implemented in due time.
Now, as we are in the green environment, you should see a lot fewer trades from us. The reason is that we think that in that zone, there is not much risk to be in, and as I said above, although we should see some considerable dips along the way, these ones could recover so quickly that trying to time an exit and re-entry could be harmful. We do have some safety mechanisms in place in case the winds change for real and other mechanism that will sell a temporary overbought position on our MLDP model.
But overall, this should be an environment where you will see us adding to our position during any dips. Since we understand that the narrative in that zone will be more about "when to add" rather than "when to sell", we will soon introduce the "Buy the Dip" alert, tentatively on April 14th. This new part of our algo will enhance our existing BTC Active Holding Signal and alert you of our entry point when we put new capital to work, while continuing to offer the same level of protection.
We should soon post our analysis of the current BTC market. We apologize for posting less recently. We have been working tirelessly on coding our SP500 package as well as our BTC 'Buy the Dip' indicator. That being said, maybe we also didn’t really need to say anything since Bitcoin is speaking for itself recently !