10 min readCrypto is a great candidate for portfolio diversification thanks to its interesting volatility and decorrelation potential. And investors looking to be exposed to digital assets increasingly turn to crypto ETPs, as they are regulated and easy-to-access products.
Once you have invested in a crypto ETP, your goal as an investor is to minimise risk while maximising performance. To do so, you will need to closely monitor your cryptocurrency portfolio. This guide will provide you with all the tools (from very simple to quite advanced) needed to accurately analyse your portfolio’s performance and make investment decisions.
Key Portfolio Management & Monitoring Indicators
We’ll start with three basic indicators all investors should be familiar with: volatility, maximum drawdown, and sharpe ratio. We’ll indicate how to calculate each of them, but you should remember that they are complementary in helping you shape a global strategy. A single indicator cannot give you an overall sense of your portfolio performance: you need to integrate multiple indicators to get a fuller picture.
Volatility
In finance, volatility measures the rate of fluctuations in an asset’s price over time. It represents how much prices swing around the mean price: bigger price swings (either rising or falling) mean bigger volatility.
Volatility can be used to assess the risk level of an asset. With higher volatility may come bigger rewards, but first and foremost higher risk. The crypto market is prone to sharp ups and downs - as an investor, you may want to adjust your exposure to volatile cryptocurrency price along the way to balance your portfolio.
Therefore, tracking how much volatility holding crypto adds to your portfolio is a simple, yet crucial risk management step to include in your monitoring process. An easy, visual way to do this is to keep track of cryptocurrency price fluctuations via your investment platform’s website.
Maximum Drawdown (MDD)
Maximum Drawdown in the maximum loss experienced by an asset or portfolio before a new peak is reached. MDD therefore also measures risk, but it doesn’t indicate how frequent drops are or how long it took the market to recover.
Monitoring Maximum Drawdown is an important risk management step when tracking your portfolio's performance. It helps you understand the extent of losses you may experience during market downturns. In the crypto market, tracking Maximum Drawdown can assist in adjusting your exposure to volatile cryptocurrency prices and maintaining a balanced portfolio.
One way to track crypto price fluctuations and monitor maximum drawdown is once again through your preferred investment platforms or exchanges: pull up the chart(s) of the digital asset(s) you're exposed to and simply visualise the downside your investment has experienced. Going even further, take a broader view and identify the MDD since the asset's last peak.
Sharpe Ratio
This slightly more technical indicator is used to measure risk-adjusted performance, i.e., the profit an investment has made relative to the amount of risk it carried. The Sharpe ratio therefore measures the excess return earned by a portfolio per unit of risk taken on. The higher the Sharpe ratio, the better the portfolio's risk-adjusted performance.
The Sharpe ratio charts the portfolio’s performance and standard deviation against the risk-free rate of return (the theoretical return on an investment that is considered risk-free, such as a US Treasury Bill).
Let’s say the risk-free rate of return was 2% over the past year, while our portfolio exhibited a 12% return, with a 15% standard deviation (a measure of volatility). The Sharpe ratio for this portfolio would be (12% - 2%) / 15% = 0.67. This means that the portfolio generated 0.67% of excess return per unit of risk taken on.
As a rule of thumb, any Sharpe ratio over 1 is considered good (as there is more financial result obtained per extra risk unit), while a Sharpe ratio under 1 indicates the portfolio is underperforming (it’s adding extra risks without the equivalent rise in results). Again, this indicator should not be analysed in isolation, and it’s even more relevant when used to compare two portfolios, especially if their return levels look similar.
Going Further: Indicators for Identifying Periods and Trends
Timing is key when making investment decisions, and correctly analysing market trends can make a big difference. We’re listing below three indicators that are mostly used by professionals - but you can still fetch them online rather easily, through TradingView.
Market Value to Realised Value (MVRV)
The MVRV indicator compares the current Market Value of an asset to its Realised Value. The Market Value of an asset is the price it’s currently trading for, while the Realised Value is the volume-weighted sum of all previous prices (charting the gain or loss made by investors who bought and then sold the asset).
If the MVRV score is above one, then the Market Value is higher than the historical Realised Value: the market as a whole ‘in profit’ – and there might be a price correction coming up as selling pressure intensifies. Conversely, a low MVRV figure shows that investors made losses and might be unwilling to sell until prices go up again. However, there is no « standard » figure of what is a good MVRV, as this depends on the asset’s history.
To learn more about MVRV and how you can use it to make investment decisions or optimise your crypto portfolio, head over to our dedicated Guide to MVRV.
Moving Averages
A moving average is simply the average price of an asset over a specified period of time. Moving averages are a commonly used technical indicator in finance that can help identify trends and potential price reversals. How? By comparing an asset's current price to its moving average over a long period of time, investors can get an idea of whether the asset is currently overvalued or undervalued.
For example, if an asset is trading significantly above its 50-day moving average, it may be considered overvalued, while if it is trading significantly below its 50-day moving average, it may be considered undervalued.
Relative Strength Indicator (RSI)
The RSI is calculated by comparing the average price gains over a specified period of time with the average price losses over the same period. The resulting figure is then plotted on a scale of 0-100, with values above 50 indicating an uptrend and values below 50 indicating a downtrend. The RSI’s main objective is to help investors assess the momentum of an asset's price and identify potential buying or selling opportunities.
The higher the RSI figure (up to 100), the stronger the uptrend is thought to be, while the lower the figure (down to 0), the stronger the downtrend is supposed to be. A figure of 50 is considered neutral, indicating that there is no clear trend in either direction. RSI values differ based on the considered timeframe: the longer the timeframe (monthly or weekly), the more the RSI can paint a long-term trend.
In Practice: Monitoring Your Crypto Portfolio Using Indicators
Now that we’ve had a look at the main indicators you can rely on to analyse your global portfolio, it’s time to put them to use.
Assessing your portfolio performance
We’ll start by comparing three long-term portfolios (investing in the market from October 2015 to November 2022).
Portfolio 1 is made of stocks (60%) and bonds (40%).
Portfolio 2 adds 4 percent of gold.
Portfolio 3 replaces gold with bitcoin. Its rounded composition is: stocks (57%), bonds (39%), and BTC (4%).
Performance: Portfolio 3 (4% bitcoin) clearly exhibits the strongest performance, with 14.4% annualised returns – almost doubling Portfolios 1 and 2’s 7% figure. That’s telling, but insufficient if we want to seriously analyse the portfolio in a risk-adjusted way. Maybe it performed well but had intense volatility, making it highly risky?
Volatility: Bitcoin being a very volatile asset, we could expect Portfolio 3 to be much more volatile than Portfolios 1 and 2, but that’s not the case. Portfolio 3’s volatility is 10,4%, 1 percentage point over Portfolio 1.
Maximum Drawdown: Similarly, Portfolio 3’s MDD is not significantly higher than Portfolios 1 and 2. It’s still worth noting that Portfolio 2 ( 4% Gold) had the lowest volatility and drawdown, as gold was a steadily rising asset during the period.
Sharpe Ratio: It therefore makes sense that the Bitcoin-enriched portfolio has the highest Sharpe Ratio, as it generated higher returns without introducing too much risk.
Advantages of Dollar-Cost Averaging
While identifying trends may help perfect your entries or exits (decisions to buy or sell), we believe BTC is an asset better analysed over the long term. We explain why in our article ‘Investing in Crypto for the Long-Term’.
In this optic, dollar-cost averaging, that is to say investing regularly (for example, buying USD 1,000 worth of crypto every month) regardless of price movements or market tendencies, has the potential to smooth out volatility. By investing with a longer horizon in view, investors might improve their risk-adjusted performance.
Conclusion: Monitoring for the Long-Term
Financial analysts have many tools at their disposal to try and read the market, and some can be quite sophisticated. You can have a look at these financial indicators before investing in a crypto asset (to see whether it is under or overvalued) or while managing your investment. However, keeping a long-term view might ultimately be more valuable than over-analysing current market situations.
ETPs can be an interesting option to regularly invest in crypto assets without spending too much time reading the market. Browse CoinShares’ catalogue here.