Overview
Based on the legendary trader Larry R. Williams' investment strategy that worked in volatile futures/options market, HEYBIT's signature "Volatility Breakout(VB)" strategy is fine-tuned to fit the cryptocurrency market with various safety measures.
VB strategy can be employed via the auto-trading bot in the global exchange, Binance.
- Compound Annual Growth Rate (CAGR) : 42.59%*
- Maximum Draw Down (MDD) : 6.93%*
- Key features: Technical trading, Short-term trading, Trend following, Asset allocation, Moving average score, Noise ratio, Volatility control, Timeframe diversification, Very low MDD.
*APR 19, 2018 ~ AUG 19, 2019
1. What is Volatility Breakout?
Larry Williams, one of the legendary technical traders, is renowned for winning the 1987 Futures Trading Championship, where he began with only $10,000 and walked away with $1.1 mil. (11,300% return) in a 12-month competition with real money. Ten years later, his 17-year old daughter, now an actress Michelle Williams, won the same contest using his strategy.
Williams is the author of 11 books including "How I Made One Million Dollars Last Year Trading Commodities" and "Long term secrets to short term trading." Volatility Breakout was introduced in these books as one of the main strategies and it's one of his favorites.
The Volatility Breakout strategy works in the following way.
⓵ Calculate the range based on the previous day.
Range = Previous day's high - Previous day's low
⓶ Make a buy limit order if the current price goes over the current price, plus the range that we calculated above.
⓷ Make a sell limit order based on the open price of the following day.
For example, let's look at the chart above.
On the left hand side is the previous day's candle, and on the right hand side is the day's candle.
In this case, the range is calculated as the previous day's high - the previous day's low = 100. Then the purchase price of today would be 960 + 100 * 0.6 = 1020. If tomorrow's market price is 1100, then it would make a (1100 / 1020) - 1 = 7.84% return, but if the market price is 1000 then it would incur a (1000 / 1020) - 1 = - 1.96% loss.
To summarize, we detect the strong upward trend(or momentum) that passes a certain range through the breakout signal on a daily basis (i.e., detecting the trend). We then follow the rising trend (i.e., trend following), and make quick profits on a daily basis (i.e., short-term trading).
Larry Williams found that prices tend to move in the same direction when a certain trend is formed, and he defined short-term trends with an incredibly simple formula. The daily process of liquidation makes a stable upward return trend by minimizing sudden big losses.
2. Applying The Volatility Breakout Strategy to Cryptocurrencies.
"Volatility breakout" records outstanding performance in a highly volatile market, as can be inferred from its name. The more volatile the market, the more pronounced the "short-term trend." Cryptocurrency is one of the most volatile assets.
There are the following four features of the VB Strategy that HEYBIT applies to the cryptocurrency market:
- Enhanced evaluation of trend: Rather than applying the previous day's range as it is, we customize the buy signal to the market by multiplying the variable k to the previous day's range. HEYBIT’s VB strategy dynamically changes the K value. This is described in detail in section 4, titled 'K Value: Noise Ratio'.
- Diversification: The strategy allocates the investment into multiple cryptocurrencies. This diversification technique has the effect of further lowering the MDD. This strategy trades 4~5 different cryptos that are highly liquid in respective exchange.
- Betting ratio: The moving average score is used. This is explained in detail in section 5, titled 'Betting Ratio'.
- Timeframe diversification: The strategy is also applied over multiple timeframes. This is described in section 7, titled 'Timeframe diversification'.
3. Operating Sequence
The implementation of the strategy has the following sequence: Select candidate Cryptocurrency -> Define breakout signal -> Make buy / no-buy decision -> Liquidate the purchased assets.
3-1. Candidate Cryptocurrencies
We select four cryptocurrencies with high market capitalizations and that are tradeable on the exchange we support.
The backtest was done to the following four types of cryptocurrencies that we are currently trading: Bitcoin, Bitcoin Cash, Ethereum and EOS.
3-2. Defining Breakout Signal
⓵ Calculate the range based on the previous day.
Range = Previous day's high - Previous day's low
⓶ If the market price goes over the target price, make a buy order.
Target price = Today's market price + (Previous day's range × K)
The K value changes depending on the noise ratio. The noise ratio will be described in detail in section 4, titled 'K value: Noise ratio'
3-3. Select Cryptocurrency to Buy
⓵ Select the cryptocurrency that had a breakout signal.
⓶ Buy the selected cryptocurrency by the betting ratio and hold the non-signal portions in cash.
The betting ratio is described in section 5, titled 'Betting Ratio'.
4. K value : Noise Ratio
The VB strategy defines a short-term trend through the range and K value of the previous day. However, having a fixed K value is not enough to cope with changing trend levels in the market and cryptocurrency. If the trend is weak, it's unlikely that the trend will continue even if it exceeds the target price. If so, setting a higher target price is needed to limit the bet. On the other hand, if the trend is strong, it's more likely to make money after the breakout. So one can increase profitability by lowering the breakout signal level.
To do this, HEYBIT uses an indicator called the noise ratio, which is an indicator of how much the crypto is trending. If the price continues to move in one direction, it is trending and has less noise. If the price fluctuates up and down frequently, then it has a lot of noise in the trend, which means that it’s not trending.
So how can one quantify the noise of any crypto's movements? In other words, how can one quantify which cryptocurrency is having an upward trend or a downward trend on a daily basis?
There is an answer, which depends on what would happen if it has a certain trend. If there is a certain trend, the length of the upper or lower shadow of the candle will be short. If there is no noise at all, it will have a long positive candle or a long negative candle with almost no upper or lower shadow. On the other hand, the long upper shadow and long lower shadow suggest that the price has been reversed during the time the market is open. From this point of view, the noise of a day candle can be defined as follows:
Noise Ratio = 1 - abs(open price - close price) / (high price - low price)
For example, the noise ratio is 1-abs (920 - 970) / (1000 - 900) = 1 - 50 / 100 = 0.5.
If you take the denominator as high - low (which equals the length of the candle) and the numerator as the absolute value of the open price - close price, this fraction represents the ratio of range between the open price and closing price to the length of the entire candle.
If you subtract this value from 1, you can use it as a simple indicator that reflects the daily noise because it is the ratio of the upper and lower shadow to the entire length of the candle. If the noise ratio is high (on a scale from zero to one), it is not trending at all. On the other hand, if the noise ratio is zero, it means there is a very pure trend. Now, this figure will be applied in the following formula:
K = the average value of the noise ratio over the last 20 days
If the average noise rate for 20 days is high, the k value will be bigger. Since the trend has been low in the last 20 days, it is highly likely that the trend will be low today. This increases the threshold of volatility, thus filtering out false trends.
If the average 20-day noise ratio is low, the K value will be decreased. Since the trend has been high in the last 20 days, there is a high probability that the trend will continue today. This lowers the threshold of volatility, so one can get on the trend quickly.
5. Betting Ratio
The betting ratio is defined as (Moving average score) × (Volatility control ratio).
5-1 Moving Average Score
In order to further strengthen the defense against the loss, HEYBIT’s initial VB strategy identified an uptrend market by comparing the 5-day moving average with the current price. However, this true or false binary approach isn't optimal. In this improved version, we apply a more sophisticated 'betting ratio control by moving average score'.
The moving average score is calculated as follows:
Calculate 18 moving averages from 3 to 20 days.
Moving average score = The number of cases that the current price is above each moving averages / 18
For example,
If the current price is above the 3-day moving average, The score would be +0.055(1/18).
If it's above the 4-day moving average, then another +0.055 (1/18).
If the current price is above all 18 of them, then the moving average score would be 1(18/18).
If it's below any of the moving averages, then the score is 0(0/18).
Moving average score of above example(Betting ratio) = 17/18
The above score is used to calculate the betting ratio.
For example, the strategy makes a full betting of 100%(18/18) for the strong uptrend that passes over all moving averages, 50%(9/18) for the moderate trend that passed over half of the moving averages, 0% for the market that doesn't have any trend that didn't go over any moving averages.
Through this process, the strategy can make bets that match the trend level.
5-2. Volatility Control (2% rule) Ratio
Controlling volatility is one of the important principles of controlling investment losses. If you bet a large amount in a highly volatile market, it is natural that the chances of losing significantly increase. Therefore, you can control volatility by reducing the amount of the bet when volatility is high and increasing the bet amount when volatility is low.
The question is, how can one identify volatility? For this, a phenomenon called volatility clustering, which means large or small changes in prices tend to cluster together, is used. Simply put, the recent volatility is likely to be similar to today's volatility.
The volatility control ratio(i.e., 2% rule) is adjusted by using the following formula.
Volatility control ratio = Target volatility / Previous day's volatility / Number of target cryptocurrencies
- Target volatility: Strategy's desired level of volatility. HEYBIT targets 2%. Not losing more than 2% of assets in a single trade is an important principle advised by legendary traders.
- Previous day's volatility : (previous day's high - previous day's low) / current price.
- Number of target cryptocurrencies: The value is 4 because HEYBIT's VB strategy trades 4 cryptocurrencies.
6. Final Formula
- Buy order placement : If the current price is higher than the opening price at 00:00 + (K × range).
- K = Average noise ratio over the recent 20-day period.
- Range = Latest 24 hour high - Latest 24 hour low
- Betting ratio = (moving average score) × (volatility control ratio)
7. Timeframe diversification
The final formula has been established, but there is one additional element to how HEYBIT operates. It is a timeframe diversifying technique. Timeframe diversification means that users' assets are spread across the different time intervals rather than gathered all at one point. HEYBIT can adjust the number of splits and timeframes based on a user's holding amount and total usage. In the closed beta phase, 24-hour partitioning is applied and it works as follows.
- Split the asset into 24
- 1/24 of the asset is operated according to the final formula in the interval from 00:00 to 24:00.
- 1/24 of the asset is operated according to the final formula in the interval from 01:00 to 25:00.
- operate 1/24 of the asset according to the final formula in section 6 above from 23:00 to 49:00
The following image visualizes this clearly:
We can see that the assets are broken down, operating sequentially in different time intervals.
The reason for diversifying the timeframes is for two purposes.
1. Slippage
if multiple users receive a buy/sell signal at the same time, it will result in a larger operation amount and, in turn, more slippage will occur. This can be catastrophic for short term trading strategies. Thanks to the diversifying timeframe technique, the slippage is drastically reduced.
2. To hedge the possibility of differences in performance by timeframe.
Even in the same VB strategy, performance can vary depending on which timeframe you operate in. There is also the possibility of a black swan appearing, and missing a big uptrend or it could result in an extreme loss from a large crash. Having multiple timeframes effectively hedges these issues and helps to ensure stable performance by flattening overall performance.
The problem is that this process is almost impossible for humans to reproduce. In the case of a 24-hour division, all formula values should be obtained and managed separately for each 24-hour time period, and numerous assets (4 assets * 24 timeframes = 96) must be bought and sold separately.
Of course, the problem can be solved systematically by using HEYBIT's automatic trading service.
8. Backtest result analysis
What was the backtest result when the VB strategy applied to the real market data?
To backtest the strategy, the data of the top four cryptocurrencies were needed. HEYBIT was able to backtest this strategy by using the data acquired from the Bithumb exchange that start from March 23rd, 2018. The following result is from April 19, 2018 (to use calculated moving averages and noise ratio with the past data) to August 31, 2019. 0.2% of slippage applied for both buy and sell orders.
* Compound Annual Growth Rate (CAGR): 42.59%
* Maximum Draw Down (MDD): 6.35%
It showed incredibly low MDD of around 6%, and at the same time, it generated a huge CAGR of 42.59%.
The black line shows the result of buying and holding each of the following four cryptocurrencies in equal percentage: Bitcoin, Bitcoin Cash, Ethereum, and EOS. The orange line is the result of HEYBIT's Volatility Breakout strategy. Just holding each of cryptocurrencies experienced a whopping +60% take-off and -87% crash. In this highly volatile market, HEYBIT's VB strategy took a stable profit and ended up making 60% return.
However, looking at this graph may raise the following question.
"Wouldn't it be better to sell everything at +60% point?"
But don't forget, there's no guarantee that we can start investing in the exact spot as in April 2018, before the surge. If we had started investing with a simple holding strategy in May 2018, we would have seen a huge loss within a short period of time. On the other hand, what if HEYBIT's VB strategy was used from May 1st, 2018?
It steps out of the market when it's crashing, but taking profits from the occasional uptrends at the same time. It's highly outperforming the simple holding strategy. Now, let's look at the numbers of the above example.
* Compound Annual Growth Rate (CAGR): 38.24%
* Maximum Draw Down (MDD): 6.93%
CAGR has declined a bit, but is still well above other investments. It is noteworthy that the MDD is consistently low. It doesn't lose much even in the big crash.
9. Conclusion
HEYBIT's "Volatility Breakout" strategy is an incredibly stable strategy. You can start to run the strategy regardless of the market situation, and it stably protects your asset even in the midst of a crash. Not only do you accumulate profits, but the process is so comfortable that it even improve the quality of your life.
This is possible through investment by HEYBIT's "Volatility Breakout" strategy.
The above details are the backbones of HEYBIT's investment strategy. However, we constantly fine-tune and enhance it to meet the ever-changing crypto market conditions. Therefore, please mind that the actual strategy employed works in more sophisticated way.
The VB strategy is currently available in Binance.
For more information on the strategy, please email us at help@heybit.io or send a direct message through the chat support button in the bottom right of your screen.
Secure and scientific cryptocurrency investment, make a HEYBIT bot now and be free from the cryptocurrency's volatility!