Crypto Is Trendy: Trakx Bitcoin Momentum CTI

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• Mar 18, 2024
Crypto Is Trendy: Trakx Bitcoin Momentum CTI

Crypto is trendy. No, we are not talking about fashion. What we are referring to is the tendency of crypto prices to either increase or decrease for sustained periods of time, providing investors with opportunities to implement investment strategies that can exploit such behaviour and in doing so generate superior risk-adjusted returns.

For academic economists such exploitable opportunities should not exist because financial markets are presumed to operate efficiently. According to this theory, investors correctly discount the impact of every sliver of news and information on an asset’s price, such that there are no consistent alpha opportunities left on the table. Of course, this is abject nonsense as every practical investor knows, hence the old financial market adage “The trend is your friend”. (If only it were that simple. Ed Seykota, a commodities trader, appended this well-known phrase with a cynical “until the end when it bends”, a well-known and appreciated twist by investment professionals).

There are probably numerous sources of such trendiness in crypto. Even though information can zap around the planet at the spend of light, it takes time for investors to understand, digest and act upon new information. This creates a lag between an event and the time its full impact is imparted on the asset price. In additional, asset prices are also impacted by the business cycle, a low frequency macroeconomic dynamic which also serves to introduce persistence in asset price returns.

These are generic reasons for judging that asset prices follow trends however, there is also a crypto-specific reason, namely considerable uncertainty as to what crypto’s fundamental value. In tradfi asset markets, decades of analysis has resulted in the evolution of various valuation models (CAPM and Fama-French factor models being two good examples). No such models have yet to be developed for cryptocurrencies, in large part because there is still no clear consensus as to what they are. For example, is Bitcoin digital gold, a competitor to fiat money, a hi-tech Ponzi scheme beloved of the naysayers, all of them or none of them. Over time this likely be resolved as the crypto ecosystem evolves and use-cases solidify, but for now and the foreseeable future the jury is out on this issue. The direct consequence of this valuation opacity is that crypto prices have a higher propensity to trend-like behaviour because the potential to get conflicting valuation signals is corresponding lower than other tradfi assets.

Crypto is Trendy. How Trendy?

We can demonstrate that crypto prices are indeed trendy by various methods. The first, one that is used much more often that admitted by investors, statisticians and economists is by simply eye-balling a price chart. Below, for example, shows the evolution of Bitcoin’s price since 2014 when Bitcoin’s market cap first hit $1bn. There is a clear upward slope to the price, albeit one punctuated by a couple of boom and bust periods.

Bitcoin Price Since 2014

Crypto is Trendy - BTC Momentum CTI - Trakx

That’s a good first step, but let’s me a bit more scientific about it. The obvious first step is to determine whether Bitcoin’s price is autocorrelated. This is a concept from time series analysis1 and examines the correlation between the price at different time lags (it is therefore capped between -1 = perfectly negatively related, to +1 = perfectly positively related). If Bitcoin’s price was purely random, ie there was no discernible trend in the price its autocorrelation function would be effectively zero. If trends are present in the data, then the autocorrelations should be positive and have larger positive values the closer in time the two observations are. When we look at the autocorrelation function for Bitcoin’s price out to a lag of 365 days (a year), we indeed find that there is positive autocorrelation – statistically significant out to more than 100 days - that gradually declines, or tapers, as the length of the lag increases. This is what we would anticipate if Bitcoin’s price is trendy.

Bitcoin Autocorrelation Function (Days lagged)

Crypto is Trendy - BTC Momentum CTI - Trakx

Having shown that Bitcoin prices does indeed display autocorrelation, which is consistent with there being a trend in its price evolution, the next step is to determine how prolonged these trending periods are.

There are various statistical methods available to address this issue, some more robust than others. The one we have used is the Mann Kendall test, which assess whether there is a monotonic upward or downtrend price trend over a given time window. Due to the fact that Bitcoin’s price has autocorrelation, the test used has to be adjusted to take this into consideration and there are several such versions. In the table below I present the results of four combined with their mode. Obviously, there is also the question as to what is the appropriate window over which to assess whether there is a trend or not. In the table below I list 30, 90 and 360 days to approximate monthly, quarterly and annual time frames.

Percentage of time trending (2018-onwards)

Crypto is Trendy - BTC Momentum CTI - Trakx

While there is some dispersion in the results per time window, with pre-whitening consistently at the bottom, the modal value is remarkably stable around the 80% regardless the length of the time window. The test statistics, confirm both our eyeballs and the plot of the autocorrelation function, Bitcoin’s price trends the majority of the time. We can show this visually in the following chart which plots the mode signal (-1 = downtrend, 0 = no trend, +1 = uptrend) from the preceding 30-day period versus Bitcoin’s price.

Bitcoin Price vs. Trend Identification

Crypto is Trendy - BTC Momentum CTI - Trakx

Exploitable Alpha

Confirming that Bitcoin’s prices is trendy implies that there are potentially exploitable alpha opportunities, but it is not a guarantee. If the trend reverses substantially before it can be identified by the strategy losses can be generated that more than offset gains. The only way to confirm this - or not - is to create a trend following strategy and calculate the returns.

Naturally, as one would expect, there are a multitude of different types of trend following strategies. The most popular are moving average cross-overs where one generates a signal based on whether the short-term moving average crosses above or below a longer-run moving average (hence the name). Our trend signal utilizes a series of moving averages (not simply averages but exponentially weighted moving averages, which adds relatively greater weight to more recent prices) but in a slightly more complex manner. The signal from the strategy can be seen in the chart below2 . Importantly, Trakx does not utilize derivative products in this Crypto Tradable Indices (CTI), meaning they are long-only products. As a result, our trend strategy only takes long signals in determining the asset allocation weight to Bitcoin (USDC accounts for the residual of the CTI allocation).

Bitcoin Price vs. Strategy Signal

Crypto is Trendy - BTC Momentum CTI - Trakx

To transform these trading signals into asset allocations, we add one further rule, which aims to smooth out the signals, namely we restrict daily asset allocations to change by no more than 50% (up or down). Hence, if we are fully invested (100% BTC allocation) and we get two consecutive days without a buy signal, then the allocation on the first day drops to 50% and then 0% the day after. Using this additional rule, the BTC allocation weights and the returns from this trending following strategy are shown below. The strategy generates an average annual return of 45% with an associated vol of 40%, to give a IRR/VOL ratio of 1.13. The Sortino ratio, which only penalizes downside volatility stands at 1.73%.

Trend Strategy (BTC allocations) And Cumulative Returns

Crypto is Trendy - BTC Momentum CTI - Trakx
Crypto is Trendy - BTC Momentum CTI - Trakx

Crypto Is Volatile: Introducing The Trakx Bitcoin Momentum CTI

As many people are aware crypto prices are volatile, which serves as a discouragement for some investors. However, due to the fact that crypto prices are trendy, it becomes practicable to implement trend following strategies that can mitigate this impact, generating volatility adjusted returns that are superior to many tradfi products. Moreover, by capping the token allocation weights it is also possible to significantly lower drawn downs.

Reflecting this, Trakx is introducing new Bitcoin Momentum CTIs to take the headache out of having to implement such trading strategies. Please get in touch if you want to know more about this innovative product.

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