How Crypto Correlation Can Help Investors with Smarter Risk Management and Better Choices

The cryptocurrency market is fast-paced, characterized with volatility, emerging classes of assets, institutional traders, and media hype. These factors have prompted investors to adopt strategies such as diversification to better manage their portfolios and mitigate losses. However, diversification is not entirely flawless.

Diversification involves investing in multiple assets at a time. However, the noise in the market makes it difficult for asset managers and investors to focus and make real returns on their investments. This is where crypto correlation comes in.

What is crypto correlation and how does it help investors manage risk and make better choices? This and more will be covered in this article.

What is Crypto Correlation?

Crypto correlation is the measure of price movements of different coins/tokens and how they align with one another. The correlation value is measured on a scale of -1 to 1, where -1 indicates a perfectly negative correlation (as the price of one coin rises, the other falls), 0 is a neutral relationship, and 1 represents a strongly positive correlation (both assets move in the same direction).

For instance, two assets with a perfectly positive correlation may not fit into an investor’s diversification pattern as they tend to move with the same momentum. A good example is Bitcoin and Ethereum – and in this case, diversification would likely not protect investors when a market overturn happens. 

On the other hand, assets with a perfectly negative correlation move independently of the other. This shows that crypto correlation is a powerful tool for innovative investors as it helps them understand the assets in their portfolio, better diversify, hedge against market overturns, and strategize effectively.

How Investors Can Manage Risk and Make a better Choices with Crypto Correlation

Crypto correlation can help investors mitigate risk and make better choices in several ways. Let’s outline and discuss some briefly.

Reducing a redundant Portfolio

A well-balanced and diversified portfolio is often made of 10-20 different crypto assets that an investor can comfortably manage. However, many investors can’t tell a balanced portfolio from an unbalanced one. For instance, holding 15 alternate coins that mirror the price movement of Bitcoin makes a portfolio unbalanced.

With crypto correlation trackers, investors can select and hold coins whose prices move independently. This way, risk can be managed in a market downturn without everything crashing.

Effectively Hedging Against Losses 

Crypto correlation can be useful for long-term Bitcoin investors who believe the coin may tank but choose not to exit the market. Correlation values can prompt them to consider other assets with opposite price movement. These coins can then serve as a hedge and limit potential losses even if the price of Bitcoin continues to dip.

Monitoring Shifts in Correlation Over Time

While crypto correlators are unique investing indicators, they aren’t always static and can change with different market cycles, sentiments, fear and greed index, and major news events. Some investors are smart enough to track these changes, evaluate them, and readjust their portfolios as necessary.

The benefits of crypto correlation are far-reaching. They can help investors with strategy building by serving as:

• Alt-season indicators especially when the price of Bitcoin falls and other smaller coins outperform.
• Trend confirmation, when multiple positively correlated crypto assets rise together and move with the same momentum.
• Indicators for hidden opportunities, especially when a low or negatively correlated coin outperforms when Bitcoin dips. This can help investors spot emerging hype that could earn them more returns.

Bottom Line 

The cryptocurrency market, though volatile, is versatile and can accommodate all levels of investors. While asset diversification remains one of the most adopted risk management strategies, merging it with crypto correlation tools makes the journey smoother. 

Your crypto correlation journey starts with choosing a tool whose features meet your investment needs. Notable planets with some of the best correlation tools in the market include CoinMetrics, Glassbodes, and Blockchain Center.