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HODL vs. Day Trading: What is the Best Strategy?

The recent downturn in bitcoin price has made many investors question the wisdom of “HODLing.” The adage of keeping your bitcoin and ignoring “FUD” has lost some of its appeal considering a bear market.

Some investors have argued that the way forward toward a healthy return-on-investment is to day trade. This begs the question of if it is best to day trade or to “HODL.”

 

Courtesy: Pixabay

Trading Philosophies

In investing, there are two camps regarding how to pump money into your portfolio. The first strategy is to pick your spots. The idea is to read the market, look for key opportunities – such as a low market price on a stock that has shown a good deal of previous movement – wait for a good time to get out, and repeat. This type of trading is known as day trading, as an investor typically buys and sells the same security in the same day.

This type of trading takes a lot of preparation. One must be well-versed in how the markets work and how one security is responding. One must be knowledgeable about world and local news that may affect the security. A day trader must be well-funded to absorb the risk of using leverage and short-term trading positions to maximize on small price movements. Typically, a casual day trader that attempts same-day buying and selling without such preparation may get lucky in the short term but will always lose out eventually.

One example of day trading goes like this: trader A is interested in buying commodity B. Commodity B is selling at $0.75 on market A, but at $0.72 on market B. Due to market price inefficiencies, the selling price for a commodity can be different on different exchanges. Trader A opts to buy a million shares of commodity B from market B and sell it immediately to market A. This is known as an arbitrage sale and it netted the trader $30,000 for one sale.

Day trading is an important safety valve for exchanges as it not only encourages liquidity but serves as a check for price inefficiency. While the typical money manager or financial advisor stay away from day trading due to the controversy behind it, a healthy exchange cannot exist without day traders. Still, one must be cognizant of the risk involved in such activity.

“Getting started in day trading is not like dabbling in investing,” former floor broker Dan Blystone wrote. “Anybody would-be investor with a few hundred dollars can buy some stock in a company they believe in and keep it for months or years. Under FINRA rules, pattern day traders in the equities market must maintain a minimum of $25,000 in their accounts and will be denied access to the markets if the balance drops below that level. This means day traders must have enough capital on top of that to realistically make a profit. And because day trading requires a lot of focus, it is not compatible with keeping a day job. Most day traders need to be able to live off their profits from trading and be prepared to risk their own capital every day to make those profits. In addition to the minimum balance required, prospective day traders need to be connected to an online broker or trading platform and have the right software to track their positions, do research, and log their trades. Brokerage commissions and taxes on short-term capital gains can also add up, so day traders need to factor all their costs into their trading activities to determine if they can do it profitably.”

The casual day trader ends up “riding the tops.” This goes like this: a would-be investor watches the news about a security’s price rising, possibly because of the excessive media coverage surrounding a new announcement or some innovation. He wants to get in on this, so he calls his broker to buy the security. The investor’s strategy is to buy the security, wait until the end of the day, and sell to a small profit. He gotten lucky before, so he feels that this is a strong strategy. The problem is that he did not pay close enough attention to the history of the security. If he did, he would have known not to invest at this point in the price spike; the price collapsed, and the investor lost a significant amount of his stake.

Long-term investing suggests that one can avoid “riding the tops” by having an established strategy for both buying and selling that does not look at the micromovements of the market, but at the market’s long-term trajectory. This is known as “playing the averages.” In crypto speak, it is called “HODLing.”

 

Courtesy: Pixabay

 

A History of HODLing

“HODL,” like most things today, came from an Internet meme. In 2013, a Bitcoin Forum sent a message with the obvious typo “I AM HODLING.” That month, after a significant price climb, bitcoin dropped from $1,118.88 to $511.39 per coin, sending the market into a stir. There was a growing consensus that bitcoin’s price bubble has “popped,” causing spikes in the daily trade volume.

There was a vocal minority, however, that felt that the dropping price was caused by FUD – fear, uncertainty, and doubt. If one was to have faith and wait for the FUD to subside, the price would recover. In other words, one needed to “Hold On for Dear Life” or “HODL.”

HODLing, as a long-term investing strategy, makes sense. Until the “price correction” on December 2017, every price drop for bitcoin was met with a price increase that topped the previous high. This “positive growth” market suggested that “riding the average” could be profitable for bitcoin.

Then, September 2017 happened. Bitcoin’s unexpected jump to $19,000 per coin created widespread speculation, messing with the average system so many long-position investors relied on. To understand what went wrong, one must take a closer look at the market during the fourth quarter of 2017.

While it is unclear exactly what happened, it is now suspected that price manipulation was behind the 2017 price spike. The Commodities and Futures Trading Commission (CTFC) suspects that practices such as spoofing, wash trading, and “pump and dump” were used to artificially inflate market speculation.

The Dodd Frank Act recognizes spoofing to be “a trading strategy in which a large order is placed on one side of the market and a small order is placed on the opposite side. There is no intention to trade the larger order. The intention is that the smaller order is traded and the larger order will be canceled.” The idea is to increase the daily trading volume. A day trader may notice several large orders going through and theorize that there is movement in the bitcoin market. Seeking to cash in, the trader places an order to lock in the low price. The trader does not notice that the original orders were canceled, and other traders notice the rash of “response trades” and jump onto the bandwagon, as well. Suddenly, you have runaway speculation.

“Traders have always used bluffs to gauge where prices are heading,” Bloomberg writes. “What’s changed is that they no longer stand face to face, buying and selling with hand signals on trading floors. Now they watch numbers on a screen. When trading was done in a pit, bad behavior was easier to identify and avoid. In the electronic age, computer programs can flood markets with fake orders. For example, [British futures trader Navindar Sarao] is accused of changing or moving futures contracts more than 20 million times on the day of the flash crash, while the rest of the market combined totaled fewer than 19 million actions. Rooting out spoofing is paramount for regulators and exchange operators to convince investors that markets are fair. In the U.S. stock market, the Securities and Exchange Commission has had the authority to punish spoofing as a civil violation since the 1930s. To help police futures markets, which are overseen by the CFTC, the Dodd-Frank Act defined spoofing and made it illegal in 2010.”

It should be said that spoofing is not the only suspect here. Tether, which offers a coin that is tethered to fiat currency, may also be to blame for the spike, as the coin was used to buy bitcoin during market downturns, artificially inflating the price.

“By mapping the blockchains of Bitcoin and Tether, we are able to establish that entities associated with the Bitfinex exchange use Tether to purchase Bitcoin when prices are falling,” John M. Griffin and Amin Shams wrote in their paper “Is Bitcoin Really Un-Tethered?” “Such price supporting activities are successful, as Bitcoin prices rise following the periods of intervention. These effects are present only after negative returns and periods following the printing of Tether. Indeed, even less than 1% of extreme exchange of tether for Bitcoin has substantial aggregate price effects. The buying of Bitcoin with Tether also occurs more aggressively right below salient round-number price thresholds where the price support might be most effective. Negative EOM price pressure on Bitcoin only in months with large Tether issuance indicates a month-end need for dollar reserves related to Tether. Proxies for Tether demand receive little support in the data, but our results are consistent with the supply-driven manipulation hypothesis.”

Bitfinex has denied any involvement in price manipulation.

Price speculation and price manipulation brought the light down on if it is fair to subject “mom and pop” investors to such a high-risk investment. Billions were lost when the “price correction” went into effect. The damage of the collapse was so severe that China, South Korea moved to ban cryptocurrencies, while Japan, the Philippines, and other nations established strict regulatory frameworks for them.

What is worse is the fact that there is little to stop this from happening again. As the various crypto exchanges are not regulated by any governmental authority, there is limited oversight to prevent more manipulative trading. This can be as benign as a trader posting misleading posts on the various crypto exchanges to fuel a minor price spike to exchanges actively engaging in trade washing, or the simultaneous buying and selling of a commodity to register a sale and create churn without the actual endangering of any capital.

As it is relatively easy to do this and as this can be done with any crypto market or any crypto asset under the current regulatory scheme, one must be critical about the validity of risk in this scenario.

 

So, Should One HODL or Day Trade?

With the recent news that the cryptocurrency market being at its lowest total value in the last two years, one can sincerely wonder if there is a key strategy for crypto investing today.

Looking at bitcoin’s historical price curve, however, offers an answer to this. If one was to exclude the $19,000 spike and the momentary turbulence, the bitcoin market followed a predictable and stable growth curve. This would suggest that a “buy and hold” strategy would work best here, but with a caveat or two.

First, one must be fully aware of the risks of the market and of coin investing. It is not acceptable to blindly enter such a high-risk proposition. One should be prepared to lose everything that he/she invested.

Second, one should have a well-established purchasing strategy. While a one-time purchase runs the risk of being ill-timed, several “installment” payments – say, a monthly or bimonthly purchase – will be less prone to poor timing. One should also exercise self-control. Just because there is churn in the market, this is not an excuse to submit to FUD.

Finally, you should have an exit strategy. It is a good idea to have standing limit orders in place to sell off your crypto stake if the price dips too low. You should also have a set amount where you would be willing to sell. It is unadvisable to create a long-term position with a high-risk investment, but – with some discipline – one can maximize the “averages” toward a strong return-on-investment.

If you were to day trade, however, be prepared. Avail yourself to all research materials available on the market and on bitcoin, study the market extensively, and check to see if any “pumping and dumping” is already happening – it is usually detectable by a rash of crypto-positive forum posts or blog articles following a price drop. Most of all, be careful; there is always someone waiting and willing to make a quick buck off someone else’s naivety.

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