Tolerating & Mitigating Risk During Extra Volatile Times in Crypto

The cryptocurrency markets went through a fairly drastic retracement, particularly on Thursday:

This kind of retracement has been seen on a few occasions over the past year since Black Thursday, but very rarely has it hurt so many traders simultaneously.

In fact, we haven't seen our Bitcoin 30-day MVRV metric (measuring the average trade returns of investors over the past 30 days) fall this low since the Black Thursday massacre from 13 months ago:

As we reported tends to be the case when a sharp and rapid drop happens in crypto, the price of BTC has rebounded mildly to just over $50,000 (at the time of this writing) after nearly hitting $48,000 for the first time in seven weeks.

However, with this being said, we still see that mass amounts of Bitcoin hodlers and traders got quite punished on this drop. And the culprit seems to be the usual story whenever BTC begins to make new all-time high levels: a severe lack of profit taking and abundance of greed.

It's Easy... Buy When Crypto is Down, and Sell When Crypto is Up... Right?

Even the most novice of traders have heard the mantra of buying low and selling high, no matter the market... but as many of us have come to realize, it can be quite difficult to actually recognize what "high" vs. "low" is. Four years ago, $5,000 would be considered incredibly high. Today, that would mean Bitcoin has fallen 90% and would be devastating to the vast majority of traders and hodlers.

Even the least volatile non-stablecoin in cryptocurrency, Bitcoin, experiences a tremendous amount of price roller coaster patterns that can be difficult for traders to keep up with. And this is why being aware of your own risk tolerance can be so important in cryptocurrency.

If Bitcoin repeated last year's history and saw a 50% price drop in a matter of hours, would this change your life drastically? For most, the answer is probably no. But as we gain more and more perspective of just how many 100x leveraged traders there are, and the surprising amount that invest a 50%+ portion of their life savings into crypto, we realize how much these reminders may be sorely needed.

FOMO (fear of missing out) and FUD (fear, uncertainty, and doubt) are very relevant topics that just about every active cryptocurrency trader has been guilty of in their journey of improving their returns. We can even see the mentions of FOMO and FUD plotted against each other as Bitcoin has fluctuated over time:

Notice how spikes of mentions of FOMO (in blue) tend to occur when prices are rising or near all-time high levels, while spikes of mentions of FUD (in red) tend to pop up as prices are experiencing drops? This is the crowd communicating to each other to enter markets before "missing out" on more gains, and reminding each other not to "doubt" Bitcoin when prices are dropping.

It's quite interesting to see that prices tend to fall shortly after these blue FOMO spikes, and bounce shortly after these FUD spikes. But keep in mind the effect is usually temporary, and markets tend to continue a fairly random trajectory after the initial day where there is some heavy correlation.

Why Take Profit Now When Bitcoin Will Probably Be Above $100,000 Some Day Anyways?

Now for a quick poll for you. Is it:

  • Better to take profit one day before an all-time high
  • Better to take profit one day after an all-time high
  • Both results will average out to be the same

Our instincts will mostly presume that this third option is the most correct, and over small sample sizes, you may be right. But take a look at this price plot for Bitcoin over the past year, with each tick in its green price line representing one hour :

Notice how there are four distinct moments in the past few months between mid-January and earlier this week where a new Bitcoin all-time high has been established followed by an immediate huge retracement. This is a common pattern that has been common in cryptocurrency throughout its 13 year-history. Even through the last year's monumental crypto rise, we see much steeper and rapid declines (in the few times that prices did decline) compared to the more gradual and consistent price rises.

Let's look at the most recent all-time high as an example:

If you were to sell exactly 24 hours before the latest April 14th all-time high of $64,863, you would have missed out on 2.85% of profit vs. somehow selling perfectly right at the top. If you were to sell 24 hours after this historical price high, you would have missed out on 3.72%. Additionally, in the first scenario, you are selling into a rise. And if selling after a new all-time high, you are selling as the price is falling (which is a much more difficult thing to do without regretting it later).

Who Needs "Dry Powder" Sitting on the Sidelines When I 100% Believe in What I'm Investing In?

By keeping some of your portfolio in cash, even just a small amount, you can essentially look to at as an "emergency fund"... and not the kind of emergency fund you need for real-life disasters, which probably belong in a bank account or safe (but that's your decision).

We refer to "emergency fund" as a least some amount being kept on the sidelines in case a massive price retracement happens, and you can call on this fund to keep your options open and purchase more when on-chain metrics or support levels dictate that it's a good idea to add on to your investment.

Being able to proclaim you're "all in" can make the "Chad's" out there give you a nice internet round of applause for having the utmost confidence in what you believe in. But not having "dry powder", as many like to refer to as extra funds to invest more when needed, can actually be a regrettable decision when a major dip happens that you can't take advantage of by adding cheaper valued crypto into your portfolio.

It's interesting how common the "buy the dip" mentality is among crypto traders, and just how foreign and almost unheard of the "sell the surge" mentality is ever mentioned. There is just as much merit to taking bits of profit as prices reach new heights, as there is buying bits and pieces as prices dip. But crowd advice only urges other traders to do the dip buying.

Profit taking, to many Twitter avatars giving you advice, is non-sensical because it means that you're "selling something in the midst of a bull market". And there is a whole lot of creative freedom these days as to what a "bull market" actually entails. Yes, the majority of this past year has been a definition of a bull market. But selling when prices rise is simply practicing good risk tolerance.

Stay away from the cult mentality that is often perpetuated by the circles of influencers and Telegram groups you see that are advising to never sell, and only ever hodl or buy more on dips. Removing 10% of your profit when your portfolio has doubled in three months is common sense in nearly any other industry.

Consider "Dollar Cost Averaging" in some spots where markets are uncertain. There are two commonly known ways to do this:

  • Buy (or sell) on a set schedule, depending on whether you're looking to add or reduce your position. For example, you're up to $500 in value in your crypto portfolio after starting with $100 one year ago, but want to take half your profit out and get it down to $300 to "lock in your win"? Set a calendar invite for the next 10 days to take $20 out every day at noon. Stay strong, and force yourself to take out this $20 (and only $20) regardless of whether the market looks like it's rebounding to another all-time high, or is in the process of potentially tanking.
  • You're in the same scenario where you want to take $200 of your $400 in profit out of your crypto investments, but want to dollar cost average based on prices instead of time? Try selling $20 of the $200 right now, then set 9 more $20 limit sells for every Bitcoin market price rise of $1,000. You will take $20 out at the $50,000 BTC price, $20 more out at the $51,000 BTC price, and so on until your last $20 sell is automatically triggered when $59,000 hits. The worst case scenario is you at least sold $20 of the $200 right before a possible market tank. The best case scenario is that you gradually get to sell all 10 of your profit portions as Bitcoin rebounds, giving you better and better prices to take profit at.

Yes, Bitcoin could some day in the not too distant future be valued above $100,000. But we can guarantee that if and when it does get there, it won't be a linear path. Sitting at $50,000 now, there is no guarantee that Bitcoin can't drop back down to $10,000 before eventually making its true climb to $100,000. Just as you've been reminded by many to not let fear influence you to sell, you also need to make sure to not allow greed to block your ability to take some occasional profits and watch your hard work and patience during an amazing one-year run all dissolve into nothing.

Thanks for reading!

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