How do we maximise the effectiveness of our investment strategy? The simplest way is to be able to exploit the volatility of an asset, which can be achieved, for example, by setting low take profit order levels. Let's take a closer look at what is the volatility of an asset, how can we exploit it and what would be the effectiveness of a 'small steps' strategy?
Table of contents:
- How effective is the small steps strategy?
- How often do you close a position in a small steps strategy?
- Is it worth following a strategy of small steps?
How effective is the small steps strategy?
If we analyse the most popular assets among investors of Conotoxia Ltd., we will see that as of 2020, the most volatile of these is by far bitcoin (with a volatility of 62% per year). In second place is crude oil (54% per year), followed much further by the Nasdaq 100 index (26%).
Source: Conotoxia own analysis
Let us analyse how often, from any entry point since 2020, the price broke through the 0.1%, 0.3% and 0.5% levels over the next 24 hours. It turns out that an increase of 0.1% regardless of the point of entry allowed the following efficiencies to be achieved in 24 hours:
- On bitcoin: as much as 97%,
- On oil: 96%,
- On the Nasdaq 100 index: 93%,
- On the DAX 40 index: 91%,
- On gold: 91%,
- On the USD/PLN pair: 89%,
- On the EUR/USD pair: 80%.
As can be seen, the percentage of closed trades with an increase of 0.1%, regardless of the point of entry since 2020, does not fall below 80%. One can also see the correlation between the volatility of an asset and the effectiveness of this approach. Interestingly, when trying to speculate on declines of 0.1%, the effectiveness is almost identical for each asset, with a variation of only 1 percentage point.
An increase of 0.3% regardless of the time of entry. Enabled the following efficiencies to be achieved within 24 hours:
- On bitcoin: as much as 90%,
- On oil: 89%,
- On the Nasdaq 100 index: 80%,
- On the DAX 40 index: 75%,
- On gold: 72%,
- On the USD/PLN pair: 66%,
- On the EUR/USD pair: 47%.
As the required rate of return increased, the effectiveness of the strategy decreased accordingly. For the EUR/USD currency pair, it would fall below 50%. Nevertheless, it is still relatively high for many assets. The gap also widened when trying to speculate on dips to the detriment of this approach - by up to 3 percentage points.
An increase of 0.5% regardless of the time of entry enabled the following efficiencies to be achieved within 24 hours:
- On bitcoin: as much as 83%,
- On oil: 82%,
- On the Nasdaq 100 index: 69%,
- On the DAX 40 index: 61%,
- On gold: 55%,
- On the USD/PLN pair: 46%,
- On the EUR/USD pair: 26%.
The volatility characteristics of individual assets become more apparent when increasing the expected growth to 0.5%. Only bitcoin and oil remain above the 80% efficiency level. In contrast, the worst performing strategy would be on currency pairs. For EUR/USD, the efficiency drops to as low as 26%.
How often do you close a position in a small steps strategy?
Knowing the effectiveness of a particular strategy on a particular asset naturally raises the question of how long one would expect to realise a profit in particular situations?
In the case of a 0.1% increase in price, we observe that a significant proportion of successful trades for most assets occur within the first hour. For example, the median trade duration for bitcoin, oil, the Nasdaq 100 index, the DAX 40 index and gold is less than one hour.
Source: Conotoxia own analysis
With an increase of 0.3%, the majority of transactions for various assets still close in the first hour. For bitcoin, the median duration until the expected rise is less than 60 minutes. For oil, the time has increased to 2 hours, while for the Nasdaq 100 and DAX 40 indices it is 3 hours. For gold and the USD/PLN currency pair, the period extends to 4 hours. The longest time to reach these levels is recorded for the EUR/USD pair, where the median duration is as long as 8 hours.
Source: Conotoxia own analysis
The duration proportions start to even out with a 0.5% increase for bitcoin and oil, trades still often close in the first hour, although the median position duration is 2 hours. For the Nasdaq 100 and DAX 40 indices, it rises to 4 hours. For gold, the median is 5 hours, and for the USD/PLN currency pair one has to wait an hour longer on average. The median duration for the EUR/USD pair is more than 12 hours.
Source: Conotoxia own analysis
Is it worth following a strategy of small steps?
A short-term trading strategy may suit traders wishing to increase efficiency by exploiting the characteristic volatility of an instrument. However, it is important to bear in mind that even a strategy with an efficiency of more than 90% may not be the ideal solution, especially if we use too much leverage and do not hedge against potential losses. It is important to keep this in mind because no matter how much percentage profit we are able to generate, a loss of capital is further likely. It is therefore advisable to have a plan in place for that unpredictable 10% probability of loss.
Grzegorz Dróżdż, CAI MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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