Story by: Ali Montag
The price of bitcoin is known for wild swings — after all, it’s a decentralized cryptocurrency that isn’t backed by any government.
Case in point: Wednesday, bitcoin’s price dropped by over 8 percent after reports that the U.S. Securities and Exchange Commission delayed a decision on a new type of financial product around the cryptocurrency. Bitcoin traded near $6,450 at 10:30 a.m. EST, according to industry website CoinDesk.
And it’s seen even more dramatic moves. After starting 2017 at under $1,000, the value of a single bitcoin topped $19,000 in December 2017, before dropping.
So it might seem impossible for the average investor to figure out which way the digital asset is headed, but a new report by two Yale University economists analyzing historical price patterns suggests there are actually two indicators you can use to get an idea.
The paper’s authors, economics professor Aleh Tsyvinski and economics Ph.D. candidate Yukun Liu, sought to “formulate and investigate potential predictors for cryptocurrency returns,” according to the paper, and analyzed years worth of past price data for Bitcoin, Ripple and Ethereum. (The prices studied for bitcoin span from 2011 to 2018, while Ripple’s XRP and Ethereum’s ether data begins at the newer currencies’ inceptions in 2012 and 2015.)
Historical data is not a guarantee for an investment’s future performance, and Tsyvinski and Liu aren’t giving financial advice, but their research reveals two factors that can be meaningful pricing tools for predicting bitcoin’s next move.
1. The “momentum effect”
The first significant factor is momentum: The report found that if the price of bitcoin increased sharply over a week, it would be likely to continue to increase for the following week, Tsyvinsky tells CNBC Make It.
“Momentum is actually something simple,” he says. “If things go up, they continue to go up on average, and if things go down, they continue to go down,” at least in the short run. Momentum has been documented in mainstream assets like stocks, bonds and currencies, and Tsyvinsky says the pattern holds true in cryptocurrencies.
In fact, the best historical strategy would have been to buy bitcoin after its price already had a sharp increase — 20 percent in a single week — and sell just seven days after buying, Tsyvinsky and Liu concluded.
Following that strategy, “the investor would have made an 11 percent [return] during the periods we looked at,” Tsyvinsky explains. The momentum effect was stronger for bitcoin than for ether or XRP, although still statistically significant, according to the report.
2. The “investor attention effect”
Second, Tsyvinsky and Liu found the amount of interest and hype around cryptocurrencies, measured by investors searching and posting online, was a significant predictor of price movements.
Looking at analysis of searches on Google for bitcoin, the report concludes, “for weekly returns, the Google search proxy statistically significantly predicts 1-week and 2-week ahead returns.” That means more searching online about bitcoin was a leading indicator that the price of bitcoin would increase in the coming weeks.
For Ripple, “the Google search proxy statistically significantly predicts 1-week ahead returns,” and for Ethereum, “the Google search proxy statistically significantly predicts 1-week, 3-week, and 6-week ahead returns.”
The number of posts about bitcoin on Twitter also gave indication about investor attention. Looking at historical data, “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,” according to the report.
And, negative investor attention can predict downturns. Increased searches for the phrase “bitcoin hack” predicted a decrease in price.
But, when considering making future investments, it’s important to remember that external factors like international regulation could impact the cryptocurrency market at any time.
“All things can happen,” Tsyvinsky says. “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.”
Original story: https://tinyurl.com/y8bnwmetby