The Recent Crypto Slump, Correlation Trading, and Portfolio Rebalancing Opportunities

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The recent crypto slump may present correlation trading or portfolio rebalancing opportunities.

Funds or even retail may look at this to allocate risk across different narratives and find uncorrelated alpha within their crypto allocation.

You could also use this to explain certain trends nonetheless:

The z-score measures how ‘stretched’ the 30D correlation (between the daily simple average returns of 2 narratives) is now Vs. the last 4 years or 1 bitcoin cycle.

A high score of +3 would imply that the 2 narratives are way more correlated than expected for that pair, while -3 implies the opposite. The narratives are also clustered based on their similarity in price movements.

A typical strategy would be to short the outperforming coin and long the underperforming coin for any pair that has an extreme z-score in the expectation that their correlation will mean-revert.

But would you necessarily go buy DEXs and sell Dog/Meme coins because z-score is +3 and you expect one narrative to significantly lag the other from here on?

Maybe not, but it could show how people have been buying DEXs recently as a speculative ‘catchup’ to the meme coin booms or as a functional token to get more access to trade the generally illiquid meme coins (not $SHIB but maybe something like Mongoose coin).

A Step Further

Maybe you thought of adding Oracles to your portfolio which already includes Yield Farming coins but you may find it useful to know that they are becoming more correlated than usual.

You could also verify how good of a hedge stablecoins and Layer 2s are to other coins in times like this. We could also go a step further to look at this within a specific narrative e.g. Gala vs Enjin to make plays on gaming platforms where the hype may jump from one coin to another.

Content in this article should not be taken as financial advice. All views and work my own. Data scraped from CoinMarketCap (before the glitch). Reach me on Linkedin!

Previously published here.