The volatility of the cryptocurrency markets makes it difficult for the average asset buyer to enter the market. News of hacks, regulations/no regulations, scams, and many other factors contribute to potential investors’ confusion. The world’s most popular digital currency, Bitcoin, is famous for wild fluctuations, sometimes in the span of just a few hours. For example, the coin is currently down about 12% over the last 24 hours, likely due to the SEC’s announcement that the agency is postponing its decision on Bitcoin ETF.
However, there may be a way to ease entry into the market by utilizing a strategy.
Two economists from Yale University have developed a basic strategy for identifying optimal buying opportunities in the crypto space.
They studied the past performance of the three best-known cryptocurrencies (Bitcoin, Ether, and XRP) and identified several metrics that can predict price movements with reasonable accuracy.
In a paper titled Risks and Returns of Cryptocurrency, economics professor Aleh Tsyvinski and economics Ph.D candidate Yukun Liu delve into historical price patterns in order to determine the critical factors that drive prices.
The pair studied price movements of Bitcoin from 2011 to 2018, the movements of Ether from 2015 to 2018, and the movements of XRP from 2012 to 2018. They identified two factors that allowed them to reasonably predict the price of these cryptoassets would move:
- The “momentum effect”: if the price of Bitcoin showed a significant and rapid increase during one week, it would likely to continue its upward trend in the following week.
Tsyvinsky explained, “Momentum is actually something simple… If things go up, they continue to go up on average, and if things go down, they continue to go down.”
Using the momentum effect, the report determined that the most risk-free strategy for trading digital assets was to buy the currency following a week in which the price had shown a significant upward trend of around 20%; and to sell another week after that.
- The “investor attention effect”: the level of interest around cryptocurrencies is a good indication of current price movements.
Google trends and Twitter posts gave accurate indications of investor attention. The report said, “A one-standard-deviation increase in the Twitter post count for the word ‘bitcoin’ yields a 2.50 percent increase in the 1-week ahead Bitcoin returns.”
The opposite also holds true – lower prices typically followed surges in searches for phrases like “Bitcoin hack” or searches related to crypto fraud and volatility.
The researchers are adamant about stressing that their findings are not intended to give investment advice. Tsyvinsky says that crypto traders should expect significant risks, even when following an academically-researched investment strategy:
“All things can happen… Maybe the statistical patterns that we find are going to completely change. Maybe tomorrow bitcoin is going to be prohibited by regulators, maybe it’s going to be completely hacked, there are many things one would take into account.”