Lesson 1 | Portfolio Optimization

This lesson introduces a new guide for The Art of The Bubble: the portfolio optimization series. It began with a joke during a coaching session.

During the 2021 crypto bull run, a friend of mine showed me his phone. He held about 60% Bitcoin and was wondering why it was struggling while so much of the market seemed to be doing better. I joked that he could just sell all his Bitcoin and re-invest it in Ethereum to double his performance.

Now, that’s not true, but my own portfolio outperformed Bitcoin by about 10x in the last 5 months of 2021 and the primary reason for that is that I’ve held so little Bitcoin. Notably, my “slowest” coin is Ethereum and it is not my top holding. 

I was also able to achieve better price stability because I worried about the correlations among the coins in my portfolio. To give you a sense of what I mean, here’s a correlation matrix.

That’s over a 30-day timeframe and you’ll notice that Pax Gold has the lowest correlation, while ETH and LINK are basically the same bet.

But what if you could find combinations that weren’t tightly correlated. What if that resulted in better and more consistent returns? That’s what most members on our Discord channel are interested in–better risk-adjusted returns (in a line).

Now, to be clear, the real heart of that outperformance is achieved through the use of the 3-stage algorithm that I describe in The Art of The Bubble series. It consists of the following:

1. A Basic Economic Cycle indicator (BEC), which tells me if the macroeconomy is good.
2. An Industry Specific Indicator (ISI), which tells me, for example, if an industry is good.
3. A Specific Position Indicator (SPI), which tells me if the cryptos or stocks I’m buying are trending in the right direction.

We can call that the 3-Stage Strategy to keep track of things in this series.

The trick in the last step of the 3-Stage Strategy turns on which coins I should be holding anyway. Honestly, I use old-school value investing to pick these coins. My analyses that I write on Quora spell out some of the thought that goes into that.

But I also use strategies for portfolio optimization, including relative performance ranking, two-way diversification, and execution risk analysis.

Very briefly, here’s what I mean.

• Relative Performance = pick coins that are doing better than Bitcoin. For the most part–notably not during downturns–you’ll get better returns by abandoning Bitcoin altogether. My paid subscribers can verify, I’ve not held anything but fractional amounts of Bitcoin for all of 2021. 
• Two-Way Diversification = diversifying logically (say by having different strategies) and diversifying statistically (through low-correlated coins).
• Execution Risk Analysis = making sure you can actually execute on the algorithmic signals and that you will have sufficient liquidity available if you need to sell.

With this optimization series, I plan to explain these points in some detail. It will also explain why I’ve been developing two new strategies for trading cryptos: the Whale10 and the Meta10.

The Whale10 uses on-chain analytics to see what every major crypto hedge fund is investing in. It picks the top 10 coins and holds those for a week and switches out. Notably, there’s not usually too much turn-over week to week.

The Meta10 is a “white box” algorithm that selects 10 coins as suggested from machine learning (AI) algorithms. It is a meta-algorithm of AI algorithms, hence the name. The idea is to hold those for a week (also) and then switch those out.

These new strategies are still in their walk-forward phase. Unlike the BEC, which has 22 years of data and a 4-year live walk-forward (including through COVID!), these aren’t yet battle-tested, which is why I’m not offering them as products. 

All of these points are important for portfolio diversification and I’m going to develop the ideas specifically for cryptocurrencies–which I think hasn’t been done anywhere yet.

Here’s what I’m planning to cover in this series. 

• Lesson 1: What is the Holy Grail of Portfolio Diversification?
• Lesson 2: Statistical v Logical Diversification
• Lesson 3: Strategy Diversification (When Lower Returns = Higher Profits)
• Lesson 4: Relative Performance Analysis
• Lesson 5: Execution Risk Analysis

So, that’s the new series idea. It’s really at the heart of what I do and what most effective fund managers do.

That’s it for this week. Remember to join us on Discord if you haven’t already.

Happy Holidays Everyone!!

Disclaimers

General financial disclaimer: This post is provided for entertainment purposes only. I am not giving you financial advice and I am not a financial advisor. You should expect no financial returns one way or another based on my statements. These points hold equally for any statements that could be attributed to The Art of The Bubble or any related business entities. If you decide to buy or invest in anything, then your returns and potential losses are your own. No statements about taxation are taxable advice and you are encouraged to consult your own tax professional. You are also encouraged to do your own due diligence before investing in anything.