Proper work with cryptocurrency begins not with the first investment, but with the study of basics. In order to put together a good crypto portfolio and start increasing their capital, investors have to spend time researching their ideas. Otherwise, it will not be possible to succeed and get income.
In our blog here we’ve already discussed different ways to do research, but we didn’t mention the aspect called correlation yet. It’s time to talk about it and learn how one can predict the price of a cryptocurrency only by observing assets.
What is correlation?
The term “correlation” came to the Crypto World from traditional finance, or more precisely, from statistics. It is the connection between different indicators. It can be positive, negative and neutral.
- If there is a positive correlation then with the growth of one indicator, the second one will go up, too.
- When correlation is negative, a reverse process is observed – the growth of one indicator and a decrease of the other.
- Neutral correlation means that both indicators do not affect each other in any way.
Bitcoin (BTC) is by far the largest and most influential crypto asset in the world. The volume of its market capitalization puts it in first place among other cryptocurrencies, according to CoinMarketCap. Due to its high popularity, BTC’s indicators are taken as a guideline for analytical forecasts.
In analytical reviews, Bitcoin is compared with:
- shares of leading technology companies;
- stock index S&P 500 (SPX);
- US Federal Reserve interest rate;
- DJI industrial index.
Recently, experts have been talking about an increase in the correlation between the indicators of Bitcoin and gold. Some believe that a bull run might soon come, since now it’s a bearish trend on the market.
Analysts associate the upcoming increase in the Bitcoin rate with risen public confidence in the cryptocurrency. It was recognized by the federal authorities. Since last year, Bitcoin has been classified as a commodity rather than a security. The connection between Bitcoin and gold is strengthening, and it itself is no longer a speculative currency, but a risk hedging tool.
Experts also say that there are no long-term correlations between the first cryptocurrency and other assets. Over the 14 years of its existence, the value of Bitcoin against the US dollar has increased tenfold. No other asset in the world can boast such high volatility.
However, in 2022, a MDPI report concluded that the positive correlation of the first cryptocurrency with other risk assets increases during extreme events, such as the COVID-19 pandemic.
Correlation and trading
Type of trading, that includes the reselling of financial assets, depends on the concept of correlation like no one else. Investors use the obtained data to develop personal strategies. Basic points of correlation analysis in crypto trading are:
- Selecting a cryptocurrency pair (two assets with a positive correlation);
- Calculation of the price correlation between two assets (it is believed that the correlation of a crypto asset should be at least 0.8);
- Determining the parameters for entering and exiting a trade.
What is cluster analysis?
Cluster analysis is actively used in cryptocurrency trading and allows an entrepreneur to diversify his investment portfolio. This approach allows us to separate assets with a high correlation index from those with a low one. Cluster analysis is used as a method for predicting the price of digital assets. Its correct use helps traders increase profits, reduce risks and prevent losses.
The correlation of cryptocurrencies helps in studying the internal processes of the crypto world and allows us to make more profitable transactions on exchanges. Assets can correlate with each other both positively and negatively, or they may not be related to each other at all.
It is not recommended to rely entirely on correlation indicators when building your investment strategies. However, this tool can be very useful if used correctly. It is better to check all the data several times using different mechanisms, so as not to once again expose your capital to risk.
Most altcoins are positively correlated with Bitcoin. The best correlation indicators for the world's first cryptocurrency are observed with ETH (0.9), LTC (0.8) and XRP (0.7). Correlation coefficients are placed in correlation matrices or tables, which are publicly available on online analytical platforms.
The cluster approach is the simplest and most understandable way to diversify a cryptocurrency portfolio. Traders categorize their crypto assets according to correlation coefficients. So it will be convenient to combine them into pairs in the future and conduct more profitable trades.