Building a crypto momentum trading strategy

Crypto momentum trading
In this and subsequent articles I’ll describe how to build a crypto momentum trading strategy from scratch.
First, let’s look at what momentum investing is and why it works in the crypto markets.
Momentum trading is a trading strategy of buying assets that have been rising in value and short selling assets that have been downtrend. Essentially, momentum investing is a bet on the continuation of current trends in the market. And as such, this type of trading works well in trending market environment. Conversely, in choppy markets momentum investing tends to show a lackluster performance.
Though buying and selling based on recent returns can seem a bad idea, many researchers have shown that it actually works. Momentum is one of the oldest investment philosophies. The great political economist David Ricardo who was also a very skillful stock trader of his day was known for his trading rules: “Cut your losses”, and “Let your profits run on”. Ricardo might not know the term “momentum investing”, but the eminent economist definitely perceived the spirit of the momentum in financial markets. These two simple rules — “Cut your losses”, and “Let your profits run on” — are the heart of the momentum trading.
As a relatively new market, crypto offers many opportunities for momentum traders. Before writing any code to implement a momentum strategy, let’s look at several reasons why momentum trading would work in crypto.
- Herding behavior in cryptocurrency markets. Imitating each other’s decisions without regard to fundamentals results in significant herding behavior in crypto markets. This leads to speculative bubbles during which some tokens can appreciate 100, 1000 or even 100,000X in value! If you are reading this book, I believe you have heard of SHIBA, PEPE or DOGE.
- Network effect. The economics of blockchain networks is typically such that the value of their tokens tends to increase as more and more users start to use the ecosystem. This triggers positive feedback — more users and developers mean a rising token which attracts even more users and developers to the ecosystem which increases the value of the native token and so on.
- Short attention span of market participants. Unlike traditional markets, crypto is always open 24/7 during a year. That markets are incessantly active implies that crypto traders can and do miss a lot of information. Therefore, many crypto investors react to market developments with a significant lag which creates opportunities for momentum traders.
- Mechanical feedback trading. Trading with leverage is widespread in crypto markets. When the market goes in one direction for a while, it triggers a lot of stop loss orders which strengthens the trend even more. Continuation of the existing trend is what momentum traders benefit from.