Why Momentum Trading Works In Crypto

Crypto markets have specific characteristics that align with a strategy of riding momentum in price movements, says Todd Groth, head of research at CoinDesk Indices.

AccessTimeIconNov 1, 2023 at 3:45 p.m. UTC
Updated Nov 2, 2023 at 1:14 a.m. UTC
AccessTimeIconNov 1, 2023 at 3:45 p.m. UTCUpdated Nov 2, 2023 at 1:14 a.m. UTC
AccessTimeIconNov 1, 2023 at 3:45 p.m. UTCUpdated Nov 2, 2023 at 1:14 a.m. UTC

Cryptocurrency markets have emerged as a highly dynamic, global financial market offering unparalleled opportunities for both active traders and investors alike. With the introduction of our CoinDesk Trend Indicator suite of signals, we hope to assist crypto investors in identifying new opportunities and managing risk in this emergent and volatile asset class.

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CoinDesk Trend Indicator

(Source: CoinDesk Indices Research)

In this post, we'll delve into the reasons why price trends exist and tend to persist in digital asset markets.

Why Does Momentum Trading Work Well in Cryptocurrency Markets?

While it is difficult to determine the exact rationale why a specific market price can exhibit persistent price changes and trending phenomena, there are a few that come to mind when considering the cryptocurrency market:

  • Limited Attention of Investors

One of the key reasons momentum trading thrives in cryptocurrency markets is the constant availability of trading opportunities. Unlike traditional stock markets that have set trading hours, cryptocurrency markets are open 24/7, 365 days a year. This continuous trading environment means investors may miss important developments, and their portfolios and trading activities may lag to market news headlines or price changes.

On top of the human limitations of trading a market that never closes, many participants within the crypto markets are non-professional retail investors, who have a lot of other daily responsibilities besides crypto markets and newsflow. The net effect of these constraints on attention to the market creates opportunities for rules-based momentum traders to capitalize on the delayed reactions of market participants.

  • Mechanical Feedback Trading

Leveraged trading and stop-loss orders often lead to mechanical feedback trading in cryptocurrency markets. When prices move in a sustained direction, stop-loss orders can be triggered and leveraged traders can be forced out of their losing positions, which adds to marginal buys or sells in the direction of the price move. This technical phenomenon can support and reinforce trending behavior, making momentum trading strategies particularly effective.

  • Network Effects

Cryptocurrencies, especially bitcoin, ether and native blockchain tokens, are supported and driven by network effects – which is to say the value and utility of these token assets increase as more users and developers join the ecosystem. This compounded growth inherently promotes momentum. As the network effect strengthens, more investors are attracted, and prices tend to follow a continuous upward trajectory.

  • Delay in Updating Views

Investor behavior is often characterized by a delay in updating views and an inclination to stick to strongly held prior beliefs. And for better or for worse, the cryptocurrency asset class is significantly more polarizing than existing and more established markets. This psychological bias can lead to investors holding outdated market views, despite contradictory market price developments.

For example, Trader A might stubbornly hold the belief that the market is still in a bull market cycle while the price trends lower. Conversely, Trader B might insist they are in the midst of a Crypto Winter, even as ether and bitcoin rally. Does this sound like anyone’s experience between 2022 into 2023?

For the reasons listed above, we should expect trending prices to persist in digital asset markets, making momentum indicators a useful strategy tool for any manager of crypto assets.

For the most current signals, the Bitcoin Trend Indicator and Ether Trend Indicator publish every day at 4 p.m. ET.

Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

  • BITCOIN TURNS 15: Satoshi Nakamoto (whoever that is) released the Bitcoin white paper on Oct. 31, 2008. That means this little crypto experiment just celebrated a nice round number anniversary: 15 years. To note the milestone, I decided to write about something I find ironic: Bitcoin debuted into a financial world that was burning (remember the financial crisis?!)  and the idea was quickly picked up by people who wanted to get rid of conventional ways of doing financial things, thus undermining the conventional firms that did those things. Today, though, the story of bitcoin and crypto more broadly is increasingly dominated by conventional financial firms. BlackRock and its peers seem to have a good shot at winning approvals for bitcoin (BTC) ETFs, which could lure a flood of new investment money. Optimism around that has fueled the recent BTC price rally. Is this a full takeover of crypto by traditional finance? Of course not. But are the firms that peer-to-peer blockchains were supposed to undermine now ascendent in crypto? They sure are. What does it mean? You tell me!
  • SBF TRIAL: This newsletter is geared toward professionals in the financial space, so, at this point, Sam Bankman-Fried is pretty much in the rear-view mirror as far as pros are concerned. He can't lobby for crypto regulations in Washington anymore, for instance, and FTX's perpetual futures didn't turn out to be so perpetual. His criminal trial has provided some good reading, however. (Keep up with our excellent SBF trial newsletter!) One thing just became clear: The media blitz he went on after FTX blew up was a bad idea. That was obvious, really, at the time, but now we see exactly why. While SBF was on the witness stand Monday, a prosecutor kept using his year-old words against him. We got a hint of that possibility last November when journalist Andrew Ross Sorkin publicly asked if his attorneys were "suggesting this is a good idea for you to be speaking." SBF replied: "No, they're very much not."
  • CME VS. BINANCE: Here's a trend that fits with the first bullet point above: CME, the giant Chicago-based exchange with roots in the 19th century, is close to overtaking Binance, the giant crypto exchange with roots in the 2000s, in terms of the notional value of bitcoin derivatives positions. CME is one of the key markets in all of traditional finance, so this fits with the idea that crypto and TradFi are converging.

Edited by Ben Schiller.



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Todd Groth, CFA

Todd Groth is Head of Index Research at CoinDesk Indices. . He has over 10 years of experience involving systematic multi-asset risk premia and alternative investment strategies.