The Single Most Profitable Bitcoin Indicator
By: Harry Nicholls
Tags: Advice, Finance, Trading, Data Science, Bitcoin

Photo by Pepi Stojanovski on Unsplash

Have you ever wondered what the single most profitable Bitcoin indicator is? In this article I’ll show you the results from backtested strategies for 6 major indicators, and reveal the most profitable one.

If you don’t know what the most popular indicators are, then read this article first, because you’ll get more out of this article if you know how each indicator works.

This experiment is about showing how useful a single indicator is as a trading signal. I backtested strategies that buy and sell BTCUSD based on signals from these 6 indicators, for a period of over 3 years:

MACD

RSI

Parabolic SAR

Bollinger Bands

Stochastic

Ichimoku Cloud

I’m going to show you how each strategy performed, compare them to each other, and also to a buy & hold strategy.

Before doing the experiment I wrote down my hypothesis:

Single indicators are not good trading signals, they won’t produce double-digit profit but they will produce double-digit drawdowns.

With that said, let’s get started!

How Did I Do The Experiment?

I’m a big fan of TradingView, so naturally I used their Strategy Tester. This allows you to backtest any strategy on any chart. Luckily they already have many strategies in their Indicators & Strategies library, so I was able to use the pre-made strategy for all the indicators, except the Ichimoku Cloud.

TradingView’s long list of built-in strategies

TradingView has a simple scripting language called Pine that is used to code strategies, so it wasn’t too difficult to edit the existing Ichimoku Cloud indicator source code to include a strategy.

The strategy consists of entering a long position when the Chikou Span crosses the price in a bottom-up manner, and entering a short position when the Chikou Span crosse the price from top-down. It took all of about 10 minutes for me to write up the simple strategy.

As I mentioned, all of the other strategies already existed in TradingView’s library, so it was just a case of adding them to my chart.

For simplicities sake, I chose to use the default parameters for all strategies.

Indicators and parameters employed for the test

I applied each of these individually to the BTCUSD daily chart. Here’s a sneak peek:

RSI Strategy applied to BTCUSD 1D chart

As you can see, TradingView plots the trade entry points on the chart. Red being a short entry, and blue being a long entry. And they provide you with a great summary table of results! It doesn’t get any easier than this.

What’s Back-Testing?

Before we dive into the results, I want to give you a bit of info about what backtesting is and why it’s useful, because it’s a great tool to have in your trading toolkit.

With backtesting, you can test trading systems against what has already happened. You can quickly see how a strategy would have performed under certain market conditions.

We’ve all heard the phrase “past performance is not an indicator of future results”, which is true, but only at the surface level. If you analyze the different market conditions and understand why your strategy performed a certain way, then you can adjust and refine it, so that it performs better in the future.

Many strategies may work well in the run-up to $20K that we experienced in late 2017, but this could be a fluke just because the market was rising. But in the downturn that we’re experiencing now, they may not do so well.

Backtesting allows you to see what happens to your trading performance in both of these different conditions, and will arm you with information to improve your strategy. And that can only be a good thing!

Be aware that good backtesting results does not mean that your strategy is foolproof, particularly in a market as young as BTCUSD. Or any cryptocurrencies for that matter! It’s very unlikely that the period you choose contains all possible market conditions. This is apparent in BTCUSD because there hasn’t been a major bear market.

You might say that we’re in one now, but only relative to what we’ve seen Bitcoin do in the last years. Relative to that, yeah it’s a bear market. But it’s got nothing on the recent bear market in oil.

The multi-year oil bear market (NYMEX Light Crude Oil price shown)

The price of a barrel of oil dropped from $106.9 in July 2014 to a low of $26.05 in February 2016. That’s a 19-month bear market that still hasn’t broken through the July 2014 price. A few months of Bitcoin consolidation is nothing.

There will be days, weeks, even months, when your system experiences big drawdowns. It’s all well and good backtesting your strategy and seeing that it lost 50% over a few weeks back in 2016, but what happens when that’s going on in real time? How would you react to that? Can you stomach watching your account being drained day after day for weeks on end? Knowing that you can stop the bleeding by turning off the system?

There’s a big difference between running a test and seeing the results, to actually going through the highs and lows of the market in real time. Backtesting doesn’t give you that experience, only real trading does.

The point is, backtesting doesn’t guarantee that your strategy is going to perform the same way in the future, because markets change. So you can’t just blindly trust backtesting. You need to be always monitoring what’s going on, always watching for changes in performance, and understand why those changes happened.

It’s very easy for anyone to open a trading account and make a few trades, it’s very difficult to consistently make a profit over a long period.

The Results

Here’s the moment you’ve been waiting for, the results! Just to remind you, my hypothesis is that none of the indicators will have positive double-digit returns and they’ll all have double-digit drawdown. Drum roll please…

Backtesting results

We’ve really got a mixed bag here. Half of them have obviously done badly. RSI, Bollinger Bands, and Stochastic, all have negative returns and drawdown greater than 10%.

I’m actually quite surprised that the other 3 indicators (MACD, Parabolic SAR, and Ichimoku Cloud) made positive returns. MACD even got a return over 20%! The drawdown for these 3 are pretty good, all less than 10%.

MACD is the obvious winner here.

And that’s it. MACD wins the title of THE MOST profitable Bitcoin indicator. See ya next time!

…

Hold on a sec! That’s not the end of the story.

The best return from any of these indicators was 22.51%. Remember that’s over a span of more than 3 years. It’s not great if you think about what’s happened to the market in those 3 years! Bitcoin has gone from $300.00 to $19,891.99 (as per Coinbase) and back down to $5,873.00. Those changes are more than 22.51%!

Take a look at the strategies compared to buy & hold. The buy & hold starts from the point the strategy makes it’s first trade. This varies, so the relative buy & hold return varies quite a lot too. But there’s an obvious difference between buy & hold and the indicators.

Indicators vs. buy-and-hold, there’s an obvious winner…

The indicator strategies pale in comparison to buy & hold. They’re just not good enough!

Even an S&P 500 tracker would have beaten these indicators. On Dec 1, 2014, the S&P closed at $2,053.44. On Mar 27, it closed at $2,612.62. That’s a gain of 27.23% in the same period as my Bitcoin study.

That’s right, holding an S&P index tracker would’ve beaten all of the strategies above!

You can do better than this.

What’s the point?

So I’ve shown you that single indicators suck. MACD is THE most profitable indicator for BTCUSD, but it ain’t got nothin’ on the buy & hold returns.

The point I want to make here is that no single strategy is perfect by itself. There’s no magic bullet. All indicators have their limitations they’re bound by strict rules, making them inflexible.

A strategy that works in a ranging market might not work in a trending market, and a strategy that works in a volatile market might not work in a calmer market. You need to be flexible in your approach. Learn to identify different market conditions, and what works best for each.

The best approach over the long-term is to change your approach as markets dictate. A sure-fire way to lose money is to stick to be rigid and inflexible when it comes to changing your style and strategy, because the market doesn’t care. It’s gonna move in whatever way it wants, and you’re gonna get washed along with it, whether you like it or not.

As always, you need to build risk management into your strategy. No matter how confident you might be in a strategy, you cannot predict every possible move, and good risk management means you don’t have to!

You have to react to what the market is telling you, a bear market won’t turn just because you prefer to long side, and a market won’t stop trending just because you want to trade the Bollinger Bounce. Be in tune with what’s happening, develop different strategies for different conditions.

You can’t rely on a single indicator or strategy to get you through.