Dangerous Strategies

In the world of finance, there're quite a few strategies that appear to be sure winners, but are in reality traps. Some of these strategies appeal to risk takers, but others appeal to the cautious, so we're not safe from falling into these traps simply by virtue of being cautious. What gets us in trouble is not so much our appetite for risk as our ignorance.

Risk on its own is not a problem as long as it's correctly calibrated relative to reward, and herein lies the key to our understanding or ignorance as the case may be. We may for instance think that a strategy that yields an above average result 90% of the time is a sensible and safe strategy. However, this information is useless on its own. Without knowing what happens in the 10% of cases when we don't win, we have no way of telling if the strategy is sound or not.

Were we to learn that in the 10% of cases that we lose, we lose everything we've invested, we may conclude that the above strategy is a terrible one. After all, we're sure to loose everything at one point or other. However, we're still not in a position to say much for certain. All we can say is that we should never go all in because that yields a 10% chance of total loss. But how about putting some money into the scheme? To make such a decision, we need to know the final piece of the puzzle. We need to know how much we win during the 90% of above average gains.

Were we to learn that the typical gains during a winning streak is above 100%, then having some money in the scheme makes sense as long as we pull our gains out every now and again. If the gains are below 100%, the scheme is in fact a sure fired loss over time, no matter how we approach it.

If we're cautious, we will only invest a small part of our money in the above scheme, and only if we feel the reward is well above 100% during good times. If we're more tolerant of risk, we may accept a return only a little above 100%, and we may want to put more of our savings in it. But only the ignorant would stay in all the time without ever taking out any of their gains.

With this in mind, we know that those who hold onto Bitcoin without ever cashing in any of their gains are sure to lose everything at some point. Bitcoin isn't going to be around for ever. Being technology, it's already old. It's not likely to be around for another ten years. It may even have topped out at this point, and subtle changes in investor behaviour indicate that this is the case. There's a special type of fool entering the Bitcoin market, ready to buy every dip going down.

This fool has been taking note of the fantastic rise in the price of Bitcoin and come to the conclusion that this thing will be around for ever. Thinking himself clever, he has also noted that Bitcoin can lose as much as 80% of its market cap and still bounce back to new highs. All that's required for him to make a small fortune is to wait for a good entry point, and then start accumulating.

This is the bag holder that typically arrives late in a cycle, and we know he has arrived because the latest peak in search interest for Bitcoin arrived late. It wasn't before Bitcoin started falling from its top that search interest took off in earnest.

Bag holders are lining up to buy whatever the whales are dumping, and their determination to stay with their misconceived strategy is likely to get them into a lot of trouble. Not only will they lose a lot of money, they will lose out on opportunities elsewhere. They may well lose a decade of opportunities and savings, a loss that few will ever recover.

Whale

By Michaël CATANZARITI - by Michaël CATANZARITI, CC BY-SA 3.0, Link