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Momentum Investing When Trading Cryptocurrencies
- What is momentum investing?
- Does this strategy work in the crypto sphere?
- How does momentum investing work in cryptocurrencies then?
With the current market situation attempting to stabilize a trend amidst the Covid-19 crisis, momentum investing may be an important trading strategy.
What is Momentum Investing?
Momentum investing is selling at a higher rate than buying, based on a strategy that capitalizes on a trend established by a stock. It can include monitoring long stocks, market ETFs and futures that are showing prices which are upward trending and then shorting assets with downward-trending prices.
The aim of this strategy is to look at the stocks’ volatility and buy stocks in short-term uptrends. Then, when these stocks lose value to sell them off. The process may be repeated over and over to obtain more profit opportunities.
Some investors may use 50-day or 200-day moving averages. A buy signal is created when a 50-day crossing rises above the 200-day. On the other hand, a 50-day crossing back below the 200-day creates a sell signal. Even longer-term moving averages can be used by momentum investors for signalling purposes.
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Does Momentum Investing Work With Cryptocurrencies?
Due to their volatile nature, cryptocurrencies are ideal for momentum investing. In traditional markets it is often deemed lucrative to buy, hold for a certain period of time and then sell (short) the winning stock. Cointelegraph reported that in the crypto world, diversification is ineffective. Thus, investors should gain more profitability from individual momentum strategies rather than focus on whole portfolios.
How Does Momentum Investing Work in Cryptocurrencies Then?
1. Investors should analyze the cryptocurrencies that they follow for a specific period, for example, for a year. Which currencies had the highest and the lowest returns for each day? What was the cumulative return? For example, Bitcoin picked up in 2019 and ended the year with a cumulative return of 65%.
2. After identifying the daily winners and losers, as an investor your strategy would be to buy the closing price of a coin and then sells it the following day. You should use the latest data in the range at UTC time given by Coin360.
Another strategy you could employ would be that of holding the coin for more than one day. An investor who buys the winners gets the best cumulative return, while investors that buy losers and sell them the following day gained a negative return.
3. Investors need to look at key factors (such as liquidity risks) when utilizing the above strategies. For instance, when a coin’s price skyrockets, it may be harder to buy it within the 24-hour period as some investors who are holding the coin might expect the coin to rise even higher. Investors must also consider the high transaction costs incurred in daily trading.
Indeed, a strategy that is based on daily trading will result in high transaction costs. In this example, we excluded these expenses from the cumulative returns and Sharpe ratio calculations. This will subsequently result in a decrease in performance after computing the impact of operational costs.