Correlation - is a phenomenon when the behavior of one asset depends on the behavior of another. The correlation expresses itself in global trends nine times out of ten in cryptocurrency.
For example, the legendary collapse of Bitcoin after the equally legendary take-off at the end of 2017 caused a significant drop in the capitalization volumes of all the other cryptocurrencies, and they fell after the crowded almost without pause.
Bitcoin is still the main favorite of the crypto market - that's a known fact, its trend is largely repeated by the rest of the coins.
BTC price reduction inevitably affects Ethereum, Ripple, Litecoin and other crypto.
Let's review the correlation as a phenomenon and consider it in terms of trading.
What is a correlation?
A positive cryptocurrency correlation is a situation when one asset copies the behavior of another.
Look at the two charts below, they show how Bitcoin and Ethereum were moving for 6 months.
Here we can say that generally Ethereum follows Bitcoin behavior: a long volatile uptrend sharply turns to a price jump, then the rate gradually decreases, of course, with periods of price correction, but remaining in a downward trend.
It’s clear that the course of ETH lags behind BTC by about a month. The peak of BTC occur in the middle of December, and ETH showed the historical maximum in the middle of January 2018.
the specificities of cryptocurrency markets
Bitcoin and Litecoin
These coins are not only similarly named: they have also a similar pricing formation, and LTC is based on the BTC blockchain, so Litecoin works according to the same principles as BTC.
Usually, these two coins have a strong positive correlation, but there are also rare exceptions. For example, while awaiting the decision of the Securities and Exchange Commission (SEC), the quotes moved in opposite directions.
Bitcoin and Ethereum
We have shown a correlation in the long-term interval. In the short term, the volatility of both coins is at high levels - around 0.7–0.9. But it falls with increasing period. This is due to the monthly delay: by measuring the correlation we take into account price fluctuations that occur at the same time.
Bitcoin and Ripple
Global Bitcoin trends are often repeated by main cryptocurrencies, the positive correlation is definitely visible in this pair. The main difference is that Ripple reacts to changes in the market in a more calmly. Let’s take a look at the chart:
Bitcoin and Ripple courses on the chart
Prices of BTC had risen sharply
Correlation ranges from -1 to +1:
- If the correlation equals 1, this means that the two assets move absolutely synchronously, i.e, they react the same to all external factors.
- If the correlation is 0, then this means that the movement of assets relative to each other is completely independent, there is no correlation.
- If it is -1, then this means that the assets are moving in opposite directions.
Look at the table below. You will see the level of correlation of the 16 most capital-intensive cryptocurrencies among themselves, as well as the connection with three fundamental indicators - the S & P500 stock market index, the VIX volatility indicator, and the gold price.
Correlation of cryptocurrency among themselves on the 90-day period
It shows that the coins, as a whole, move synchronously, but somewhere the connection between the individual currencies is higher, somewhere below. For example, the correlation between ether and bitcoin on a 90-day segment is 0.5, between Bitcoin and Monero the coefficient is 0.6, and between Zcash and Monero, even 0.81 - these two coins move almost synchronously.
Correlation value for traders
If your portfolio has been balanced - this will minimize losses in case of strong market impacts.
First thing first, It is important to choose such currencies with a negative correlation, in which case the decline of one is compensated by the growth of the other - or at least or had no correlation between themselves at all. To determine the correlation, mathematical approaches based on formulas and special indicators, for example, iCorrelationTable (this is an example, not a recommendation).
If all currencies move together, then the portfolio will grow ups and downs in capitalization synchronously with the market fluctuations as a whole.
Second things second, it is useful to think over your strategy in case of different variants of the general market mood, follow it and act strictly according to your plan. For example, when the market is ready to turn around for growth, one can transfer part of fiat in crypto; if the capitalization of the crypto market is expected to decline, withdraw part of the coins to the fiat and accumulate funds for purchase after the decline.
In the medium-term and long-term markets:
Bitcoin remains the major cryptocurrency. To predict the behavior of altcoins you need to understand the main principles by which other assets copy its behavior.
In the case of Ethereum - this is a delay. This means that after a sharp price spike in BTC, a similar response from the ETH is likely to follow. A small time interval, in this case, working out well for some traders.
In derivatives markets, correlation does not play a key role:
At time intervals of 5–60 seconds, crypto is rather erratically. On such timeframes, candles and bars are formed according to the laws of technical analysis.
You should not take the correlation too literally and it is very important to learn how to correctly determine the trend.
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