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Probability vs. Possibility: Did you risk manage your Crypto investments?

Please read the disclaimer here: https://en.theadaptive-investor.com/disclaimer


I want to share two important insights in this article with regards to the way a lot of people seem to invest in Crypto assets. My goal is not necessarily to give my current views on where we are, or where we are going.

What I would like to do is give an investment insight with regards to how a lot of people seem to invest in Crypto assets. In my opinion, a lot of (inexperienced) investors are making a big mistake in the way they invest in these assets.

This is thus not about the why, but about the how.


Before I share the two important insights, I'll give a quick reminder of my views on Bitcoin throughout this year:


-Late April I warned that the Bitcoin price action was not looking good. Prices dropped sharply.


-Late July it looked to me that Bitcoin would break down. I was wrong on this and it bottomed. I changed my views and became bullish after it could break above the 41 000 level.


-Early October I made a video about the bullish price action I was seeing in Bitcoin. (see here) We reached all time highs again and I wrote I would like to see a consolidation after which we could move higher. The consolidation happened but we saw a strong failure over the last few weeks.

I shared the following chart in an article of early November (see here) in which I explained why you shouldn't be afraid to buy all time highs in Bitcoin.


Needless to say, this call was completely wrong, as we can see on the following chart of Bitcoin.


(Quick side note: Even though that call was completely wrong, the investing insight from the article is still completely right: you shouldn't be afraid to buy strength and all-time highs. The best traders in the world do it and if you look at it from a statistical viewpoint, it is the right thing to do.)


How did I manage my positions? Well, I've been positioned in ETH and not in BTC. I started building my positions in the middle of September. As you can see on the following chart, ETH remained relatively strong in comparison to BTC. BTC failed on the weekly timeframe to hold its breakout above all time highs. ETH however managed to stay above those all time highs.

The fact that ETH remained relatively strong, game me the opportunity to take a wait and see approach. (If I was positioned in Bitcoin, I would have sold much earlier.)


On the 10th of December I sold my whole ETH position. Why? Just as Jesse Livermore would advise not to be afraid of all time highs (as explained in this article), he would also advise to be cautious when prices don't react as they should. See tweets below:



Normally when BTC can break above all time highs, we see a parabolic move. The following chart clearly shows this:

source: @Erik_Hansen_


I gave ETH several weeks of time to prove itself, knowing well that BTC had already failed.

But it's taking too long and the price action is just not looking constructive if you ask me. (In 2017 we also saw a failed breakout first in BTC before the parabolic move started but that price action was much clearer then now. See here for charts.)

I'm not going to share a bunch of charts here, you can see some of them on my twitter account.

The important thing to note is that I went from being extremely bullish in early November, to selling my whole position. I'm not willing to let a profit turn into a loss because I want the price to rise or because I'm stuck to my fundamental views. Risk management is key:


This brings me to the two important lessons I want to share. These are lessons on how you can intelligently invest in crypto markets. (This is thus no opinion on why you should invest in them.)

I think a lot of people make two mistakes.


Mistake number 1: There are a lot of people that make fancy charts based on technical analysis and on chain data (The interesting thing about crypto is that we can use this on chain data to see what people are actually doing, this way we can get unique insights into the crypto markets that we can't get in other markets.)

There is nothing wrong with making these charts. I follow a lot of people and I use their analysis in my investment process. The problem is however that a lot of people seem to believe almost fanatically in certain indicators. (Whether they are technical or on chain indicators.) They also seem to invest on probabilities instead of possibilities.

Before I go on with this probability vs possibility debate, let's first talk about all these indicators.

When you start out investing, you tend to follow a lot of people and you start to get into contact with technical analysis and all kind of indicators. You think you need to find the person that can help you to get the magical indicator. Unfortunately, after a lot of years you will learn that this perfect indicator doesn't exist.

Please, take the following advice from Aksel Kibar, it will save you a lot of effort (and money):


Why do you think I almost never use indicators on my chart? Because I learned the hard way that they don't work. If I use them, I use Fibonacci retracements/extensions and RSI. And the way I use them is most of the time not the way that they are taught in the textbooks...


Why do you think that great traders like Mark Minervini, William Eckhardt, Monrou Trout,... seldom use indicators?

Because they learned the hard way that they don't work.

Don't believe me? Look at what they say:


Jack Schwager: “Any indicators that you consider overrated?”

Monroe Trout: “Most of the common ones: Fibonacci retracements, Gann angles, RSI, and stochastics. I haven’t found anything there for any of these indicators.”


Jack Schwager: “Do you have any opinion about popular technical overbought/oversold-type indicators, such as RSI and stochastics?

William Eckhardt: “I think these indicators are nearly worthless.”

Do I want to tell you that all technical analysis is bullshit? Absolutely not, technical analysis is a big part of my process. But what I want to share is that the way a lot of people use it is completely wrong. There is no magical indicator and there is no secret model that always works. Remember this when you invest your money based on fancy looking chart you see on Twitter. You can use it in your process (like I do), but don't let it be a factor that will impact whether you make money or not. To make this more clear, we need to look at the second mistake a lot of people make.


Mistake number 2: There are two intelligent ways, and one very stupid way, to invest in Crypto assets in my opinion.

Let's start by one of the two intelligent ways. If you have a broadly diversified portfolio with stocks, bonds, gold, commodities,... and you want to invest a part of this portfolio in crypto, I see no problem at all. You can do 'buy and hold' since the risk is only a small part of your whole portfolio and it is thus contained.


A very stupid way to invest in crypto assets is to use this 'buy and hold' approach and invest a significant part of your capital in these crypto assets.

Warren Buffett is the ultimate buy and hold investor. The reason for his long term success is that he admits that he can't predict the future of most companies. This way, he only sticks to what he knows and invests in a very select group of stocks; those with certain competitive advantages, a stable business model,...

Warren Buffett isn't successful because he can predict the future. He is successful because he admits that he can't predict the future of most companies and therefore sticks to a very limited number of stocks, as he explains:


Warren Buffett: “If a business is complex or subject to constant change, we're not smart enough to predict future cash flows. Incidentally, that shortcoming doesn't bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes.”


The mistake that buy and hold crypto investors make is that they take this buy and hold mentality of Warren Buffett to invest in an asset that has none of the characteristics that makes buy and hold work.


I hope that I don't have to explain that the future of digital assets is much more uncertain than the future of well established stocks with competitive advantages, a strong consumer base,...


If you ever see someone quoting Warren Buffett's line 'Be fearful when others are greedy and be greedy when others are fearful.' with regards to the crypto market, you now know that they have no idea what they are talking about. Buffett can say this because the type of companies in which he invests are very specific. Crypto assets are on a whole other level.


Now, what is the second intelligent way to invest in Crypto assets? This is the method I use. I use the insights from great traders like Druckenmiller and Soros to invest in this space.


Warren Buffett is successful because he manages his risk by investing in a very small spectrum of stocks.

The diversified investor who invests in crypto manages his risk by only investing a small part in the space.

The buy and hold crypto investor doesn't manage his risk at all.


How does Druckenmiller (and Soros) manage his risk when investing? Well, he's a great trader and just as Jesse Livermore, he doesn't let his fundamental views influence his money making ability. If the market tells him he is wrong, he'll adjust.


Stanley Druckenmiller: “If you are going to bet big, you have to be ruthlessly objective about your position. I’ve put on positions I was a 100% sure I would have for 2 or 3 years and 10 days later, in my opinion the facts changed, and I’m out of them. If you are going to go the rout of making concentrated bets, you also have to go the rout of being completely open minded. When the facts change, being wrong, you can’t sit down there and double down. If things don’t start to work out, you have to exit the position.”


He doesn't advise to just stay in the market and pray you are right. No, he advises to admit your mistake and manage your risk. That's his key to success.


Let's look at Soros. As the following quote shows, he is extremely uncertain of his views. This gives him the flexibility to change his mind quickly. The reason for his success is not his ability to predict markets (he made plenty of mistakes). The reason for his success is that he was always quick to recognize his mistake and to risk manage his positions.


Soros: "I was afraid to admit my success because it might undermine my sense of insecurity. Once you take your success for granted, you let down your guard. When you are in trouble, you just sit back; you know you are successful and you will always get out of trouble somehow. That’s when you have lost your ability to get out of trouble."


Note that one of the best investors ever is very uncertain of his views and didn't want to admit his success because he was afraid that it would impact his ability to risk manage his positions. Compare this to the experts on Twitter...


Let's go back to the following sentence I wrote earlier: They also seem to invest on probabilities instead of possibilities.

Investing on probabilities is a good idea because it implies that you take into account alternative scenarios playing out. But it doesn't necessarily give you any risk management.


Have a look at the following chart. The colored line shows the evolution of the Bitcoin price. The grey line is a composite of several technical and on chain Bitcoin indicators. The higher the grey line, the higher the chance that we have seen the top in the Bitcoin market. As you can see, a peak in the grey line indicated both the late 2013 and late 2017 top in the Bitcoin price.

Source: https://colintalkscrypto.com/cbbi/


Someone who thinks in probabilities will look at the current situation and say the following: "The indicator is not as high as was the case at previous market tops. Therefore the probability that Bitcoin hasn't topped yet is higher than the probability that we have entered a bear market. Since probabilities are in my favor, I'll stay invested in the Crypto market."


As you can see, no risk management here. As Alex Barrow from MacroOps wrote: "Thinking in probabilities leads to false confidence and suboptimal outcomes."


Why is the Druckenmiller & Soros way of investing in Crypto much better?

Let's look at what I did. In early November I was a huge bull on the Crypto market. Since price action didn't follow through, I adjusted my views and risk managed my position by selling my investments. If the Crypto space continues to decline in value, I'll lose nothing. If the market takes off again, I'll be open minded enough to get back in.

What will the buy and hold investors get who have a significant part of their portfolio in Crypto? If the price rises, they'll make a lot of money. But I'll make a lot of money as well because I'll get back in.

The difference is that when the price continues to decline, they'll lose a lot of money. Me on the other hand, I'll lose nothing.

Why? Because I gave attention to the possibility that this cycle is different than previous ones.


Who will you follow? An analyst on twitter with a nice looking chart who is certain of his fundamental views that prices will go higher?

Or the insights of Soros, Druckenmiller and Livermore? They would advise you to be open minded, to risk manage your positions. Think in possibilities, not in probabilities. The world is a very uncertain place, nobody can predict the future.

The probability that we haven't seen the peak might be higher than the probability that we have (not necessarily my opinion), but the possibility that we have seen the peak is the risk that will ruin a lot of investors.

Please manage this risk, it's the only way to long term success, and in my opinion, a much better way to invest in the Crypto market.


Thank you very much for reading my article!

You can follow me on Twitter: @adaptiveinvest





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