The volatility of digital currencies is both an opportunity and a threat to investors. The price swings are wild. Bitcoin, for instance, has gone all the way up to $19,000 and down to barely $6,500 in a matter of months. While it has helped make a few people rich, it has also created a very risky and unregulated asset class that has attracted a lot of speculative investors. However, two Yale economists have now come up with a method to determine the right time to invest in this currency.
New Report Reveals All
A new report based on the historical price analysis of Bitcoin reveals the only two indicators that one needs to look into before investing in the currency. Prepared by economics professor Aleh Tsyvinski and economics PhD candidate Yukun Liu, the research aimed to “formulate and investigate potential predictors for cryptocurrency returns.” They also took data for Ripple and Ethereum between 2012 and 2015, while Bitcoin’s data have been collected from 2011.
These Factors Indicate Bitcoin Movements
The first factor that one should consider is the “momentum effect.” In a CNBC interview, Tsyvinski describes that if the price of Bitcoin has increased sharply for over a week, it will continue doing so for another week. He said:
“Momentum is actually something simple. If things go up, they continue to go up on average, and if things go down, they continue to go down.”
The momentum indicator is also applicable in traditional asset classes (with different parameters though), but still holds true for digital currencies, as far as short-term trades are concerned.
Both researchers concluded that the best way to maximize Bitcoin returns is to buy when the price has increased by 20 percent in a week and sell after seven days. An investor who had adopted this strategy could have received an 11-percent return. This effect was more strongly associated with Bitcoin or Ripple.
Investor Attention Matters Too
The second factor that one must consider is “investor attention effect.” The interest and even hype around a particular coin and even online search trends and conversations could help in predicting price movements very significantly. The report suggests:
“[F]or weekly returns, the Google search proxy statistically significantly predicts 1-week and 2-week ahead returns.”
This means that more online searches will mean ascension in prices and indicate a profit for those who intend to go long. For Ripple, the Google search proxy predicted 1-week returns, while for Ethereum, 1-week, 3-week and even 6-week returns became predictable.
Apart from Google, Twitter also acted as a measure of investor attention. Data suggest that one-standard-deviation increase in the Twitter post count for posts including the word “Bitcoin” leads to a 2.50-percent increase in Bitcoin prices for the next one week. A similar effect, albeit negatively, can be associated with phrases like “Bitcoin hack.”