The Importance of Correlations in (Crypto) Trading
Why the appliance of correlations could be a very valuable tool to fortify your portfolio during both bull and bear markets
Note: This is my first post on Substack so the end result might not look very optimal yet since I’m just in the ‘‘try-out’’ phase. Also note that English isn’t my first language, my first language is Dutch.
Today I will talk a bit about the correct appliance of ''correlations'' in trading, especially for trading crypto. I just know for a fact that everyone is very excited to hear more about this, see the link down below (source) for a more detailed explanation as to what ‘‘correlations’’ actually are but here is the core concept:
''Correlation: Positively correlated variables tend to move together, negatively correlated variables move inversely to each other, and uncorrelated variables move independently of each other.''
So, I hear you thinking: ''what can I do with this?''. Well, almost every ‘‘altcoin’’ or ‘‘crypto coin/unit’’ (in the future I will mostly refer to ‘‘altcoins’’ as ‘‘crypto coins’’ or ‘‘crypto units’’) is positively correlated with BTC (Bitcoin). That is due to the fact that the general crypto market as a whole still follows the price movements of BTC to a great lenght. But (and this is what makes it interesting as a tool for trading and diversification) there do exist significant differences between different crypto units in regards to their respective correlations to BTC. That implies the existence of significant differences between different crypto units in regards to what lenght those respective crypto units will follow the price movements of BTC.
So, I hear you thinking again: ‘‘how do you apply this knowledge to your trading and diversification strategies?’'. When for example BTC goes down it is very likely that the general market will follow in it’s footsteps, in such a situation you will want to diversify into crypto units or coins that are much less strongly (or much more loosely) correlated to BTC than most other crypto units. The inverse strategy is (of course) also true for when BTC goes up, in that situation you will want to diversify into crypto units that are much stronger (or much tighter) correlated to BTC than most other coins. The (free) tool/site below (there are much more sources to be found for this) also allows you to dive (or generate) into the direct correlations between the many different altcoins in existence. Between all these tens of thousands of different crypto coins (altcoins) you will find much more divergence in correlations (even negative correlations) than you will find in their individual respective correlations to BTC. But the appliance and mechanisms to achieve better diversification and trading strategies stay the same in either case nevertheless.
Example of a correlations table or matrix:
Source:
https://cryptowat.ch/correlations
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