There is a great deal of talk about an upcoming recession, which would be, by many estimations, the most forecasted recession in history.

Whether that is true or not is subject to debate, but this is certainly a difficult time to be making asset allocation decisions.

According to the US Leading Indicators Index we may already be in a recession. Historically this indicator has always predicted a recession since the 1970s when it drops below -4. A system built on trading this indicator since the 1970s would have outperformed the market by +2%:

However, there is another set of indicators that we cover in this article which analyses the Financial Stress Index and the Chicago Adjusted Financial Conditions Index. When this indicator is below 0.5 the market outlook is very bullish and, lo and behold, it has been trending in a bullish direction for the two weeks:

The macro environment is anything but clear. So one of the core arguments towards allocating capital towards Bitcoin (BTC-USD) is that when the fiat monetary system comes under duress, people will flee from the US dollar and US-denominated assets (including stocks) and take refuge in Bitcoin. In 2022 Deutsche Bank, Goldman Sachs and others jumped on the bandwagon claiming Bitcoin is the new "21st century gold." That narrative is alive and kicking, particularly amongst the younger generation.

I intend to show that the opposite holds true. Bitcoin and other major cryptocurrencies are fairly predictable using basic technical analysis and moving average tools. They show heightened volatility and therefore, at either extreme, will either out-perform the index or significantly under-perform the index during times of market stress.

Let's not forget Bitcoin had a -72.6% drawdown in 2018 (when equity markets drew down) and a brutal -81.02% drawdown in 2022.

A counterintuitive - and arguable quite profitable investment approach - would be to short Bitcoin in preparation for the next recession.

Specifically, I intend to show that a systematic moving-average based trading system enables you to take a concentrated short- or bearish position on Bitcoin while also reducing the downside risk if the trade doesn't work out. Equally it allows you to capture up-side bullish trends and profit both ways.

The essence of this piece is that Bitcoin isn’t quite as unique as proponents feel it is and many of the old-school tools that used to work in equity markets, work fantastically well on Bitcoin. Let’s dive in.

Moving Averages – Trading Bitcoin

We have covered in detail previously how the S&P 500 index used to respond to moving average trading between 1951-2000. This means that an investor could have used the 170day and 200-day averages to trade the stock indexes up to the year 2000 quite successfully.

What if we applied those tools to Bitcoin? To assess this I performed an experiment using Python to understand how a system trading Bitcoin using basic moving averages would perform. I tested all major crossover levels over multiple time-frames to arrive at the most successful. The results were interesting:

Under multiple timeframes the 23-day moving average and 120/150 day moving averages outperformed the BTC-USD buy and hold index. Overall the 23-day moving average had the best outcome 2013-2023 YTD.

The system buys when BTC is above its 23 DMA and sells when BTC is below its 23 DMA.

Overall returns were $9,910,000 against $59,697.2 for a buy and hold strategy.

The Gain to Pain ratio is a whopping 7 representing the ratio of max gains to max losses.

There are 35 total trades since 2018 with a 41.4% win ratio:

How does this system work?

If you look at the blue circles these are periods where the system whipsaws around. Meaning: you have sudden moves above and below the 23-day moving average that have led to small losses.

In terms of descriptive statistics, the python backtest shows that our average Buy signal is positive 14 times and negative 21 times. That appears to be a low percentage on the surface with only a 40% win rate. But look at what happens when it is right – Bitcoin rises 39.36% on average during major trends (UP) and only loses -4.44% when it is wrong and gets whipsawed.

Conversely Sell signals are more common (60% of the time) and when they are right, the drawdowns that are avoided are 17.04% when it is right and only -5.59% when it is wrong and BTC-USD rises on a sell signal.

Correlation between S&P 500 Index and BTC-USD

The statistical relationship between S&P 500 Index, represented by SPX, and Bitcoin, represented by BTC-USD is a weakly positive correlation of 0.2 with wild variations:

Over the course of 2014-2023 correlation doesn’t tell us much because it vacillates between being strongly positive and strongly negatively correlated.

However if you look closely at the chart there is a pattern here. During the majority of 2022, from January 2022 until early November, Bitcoin had an average correlation of 0.69. It stands to reason that if we return to a period of instability and poor market returns like we had last year, we could get a repeat occurrence of positive correlation again, where the underlying follows the weakness in the stock market. It tracked the market nearly perfectly!

This disproves the thesis and belief that Bitcoin is a countercyclical asset. Look to other areas of the market like commodities, gold, or short term credit to perform better and also high dividend value stocks.

Selling Bitcoin (BTC-USD) in May 2023 and Going Away

Drilling down into where we are with Bitcoin in April 2023, we have very recently hit a sell signal:

On the 19^th of April 2023 Bitcoin dropped decisively below its 23-day moving average. Based on this system the likelihood is that we will experience a drawdown in Bitcoin and that it could be significant, and therefore Bitcoin (BTC-USD) is currently a sell.

If the system is right then we’d expect an average drawdown of -17.04% in the underlying asset. If the system is wrong and giving a false signal, we’d expect an average gain of 5.59% in the underlying asset.

Either way one would close this trade when BTC-USD returns to its 23-day moving average and goes back above that threshold.

Actionable Investments

There are several options for shorting or going against BTC-USD.

For those who would like to take an ETF approach, there is the ProShares Short Bitcoin Strategy ETF (NYSEARCA:BITI). The ProShares ETF BITI aims to deliver -1x the return of the BTC-USD Bitcoin index for a single day. It also has a Canadian equivalent for those that reside North of the border.

If we look at the BITI ETF and the underlying asset (Bitcoin), it tends to perform its job well with an average negative correlation of -0.7 or 70%.

This option is perhaps the easiest however would blunt returns on account of the fact it doesn’t perfectly follow the index and there are transaction costs (it has an expense ratio of 0.95%) and slippage because it uses derivatives.

The second option would be to short BTC-USD directly through a broker that deals with Cryptocurrency. Tastyworks, for example, allows you to trade directly in Bitcoin and Bitcoin futures. A short position on BTC-USD could be entered with 28,947.73 as the sell point (sell at or below the 23-day moving average). There are of course challenges with this approach as investors would need to act fast when a signal trades: waiting could lead to unpredictable results and significantly higher drawdowns then this system predicts.

For a high risk strategy – which is not recommended – there are 3x leveraged Bitcoin ETFs and specifically BTC3L that could be used to gain 3x long exposure to the index, and conversely BTC3S for short exposure to the index. These represent 3x the return of the underlying and in practical terms produce results more akin to 2.5 to 2.7x the return of the underlying.

Overall my assessment would be that using the ProShares ETF (BITI) is the safest and most liquid option to gain exposure to this idea. For those with experience a BTC-USD short position could be considered particularly if you have the capacity and ability to act fast and immediately on signals. Finally, for the riskiest option, a 3x leveraged Bitcoin ETF could be used, however involves significant risk to capital and is therefore not recommended on the basis of costly drawdowns.

Editor's Note: This article was submitted as part of Seeking Alpha’s Best Investment Idea For A Potential Recession competition, which runs through April 28. This competition is open to all users and contributors; click here to find out more and submit your article today!

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