How to Find the Best Stocks that Correlate to Crypto-Currency
Crypto-currency started in 2008 with a white paper on Bitcoin with a peer-to-peer cash transaction alternative to create a digital currency. The goal was to create a decentralized ledger for digital currency. Since that time, a blockchain has exploded and the number of Altcoins has also increased. A Bitcoin Exchange has been created and the value of altcoins has also increased significantly.
However, Bitcoin is the most valuable and heavily traded digital currency.
Digital Currency trading platforms have been created to allow for online trading, similar to stock trading.
However, for many trading digital currency directly presents security risks, and many stock traders seek stocks that correlate crypto-currency, as a way to capture a change in bitcoin value that has occurred in the past few months, and expected by many to continue.
For many years since the inception of Bitcoin, the correlation of bitcoin to the broader S&P and Nasdaq Markets has been below 0.5. Meaning it is only about 50% or less correlated to how the broader markets are performing. However, in recent months Bitcoin has increased its directional correlation with the Nasdaq as can be seen in this chart.
Bitcoin identified as the bars and the Nasdaq as the purple line.
As one can see the value of bitcoin has surged significantly over the prior several months.
The question remains how do you find the best stocks to trade that have a strong correlation to Bitcoin and other Cryptocurrencies, independent of their underlying correlation to their index?
Cryptocurrency trading provides an alternative asset class to trade for many investors, but many do not want to buy digital currencies directly as they are concerned about security issues.
Bitcoin and cryptocurrencies are seen as a potential way to diversify portfolios and reduce portfolio risk. However, many individual traders and investors are reluctant for a variety of reasons to put large percentages of their portfolios directly into Bitcoin, Ethereum, and other cryptocurrencies. Many traders and investors are looking for alternative ways to trading stocks to capture some of the movement of cryptocurrencies, without direct buying of a cryptocurrency such as Bitcoin.
In response to the surging value of bitcoin, many firms have developed Bitcoin ETFs to try to track the price movement of bitcoin for clients. Each day more financial instruments are coming online to allow investors to gain exposure to the cryptocurrency market without direct investment in buying digital currency.
Also, many companies have decided to add crypto-currency to their balance sheet or start to use crypto-currency for some transactions. As a result, investors are trying to use the stocks of these companies to gain exposure to the cryptocurrency market.
Each stock has a different correlation to crypto-currency and provides different risk and reward opportunities for trading stocks.
In this post, we will explore some of the different stocks and ETFs, and analyze their correlation to digital currency.
First, what is the Pearson Coefficient?
The Pearson Coefficient measures the strength of correlation between two variables. In this case, we are talking about the correlation between Bitcoin and other stocks and ETFs.
The Pearson Coefficient Formula:
X and Y represent in this case a stock or ETF (X), and Bitcoin (Y).
Since Bitcoin is the largest and has the highest trading volume, we use Bitcoin as the benchmark for crypto-currency.
The number of stocks that are adding crypto-currency to their balance sheet or incorporating in some other way to their company is ever-growing.
For today we will focus on 4 stocks.
First let us start with Microstrategy, ticker MSTR and it trades on the Nasdaq. Microstrategy is a software company, but its CEO, Michael Sayler started in 2020 buying bitcoin and added it to the company’s balance sheet.
As a result, the stock has had a big rise in price. It currently has significant volatility as a result of its bitcoin holdings. However, as a tech stock, it also has a strong correlation to Nasdaq.
MSTR(purple line) in comparison to a chart of Bitcoin (Bitcoin Futures), BTC.
One can see there is generally a strong correlation in direction, though the peaks and valleys vary in their extremes.
However, Microstrategy is also a technology company and as a result, has a strong correlation to the
Nasdaq 100 basket of stocks, ticker QQQ.
To add another layer of complexity, Bitcoin itself has some correlation to the Nasdaq 100 also.
Using the Pearson Coefficient as a measure of correlation over the past 5 days, Bitcoin has a 0.61 correlation to the Nasdaq 100. Meaning there is a moderate correlation.
So how do you determine if Microstrategy is just responding to directional price changes in the Nasdaq or Bitcoin?
RPMAssets prefers the Pearson Coefficient combined with chart analysis that we teach our free Newsletter Subscribers.
In this case for Microstrategy:
The Bitcoin Pearson Coefficient to Microstrategy = .54
The Nasdaq Pearson Coefficient to Microstrategy = .92
So one can conclude over the past 5 days the price changes in MSTR are more strongly correlated to the Nasdaq, and less so Bitcoin.
Square (SQ), is another company that is incorporating Bitcoin into its business model.
Square has been purchasing Bitcoin and now Bitcoin represents about 5% of its total assets.
As a result, SQ is another stock with a strong directional correlation to Bitcoin as can be seen in the chart below.
However, like MSTR, Square is another company that is strongly correlated to the Nasdaq.
The Pearson Coefficient for Bitcoin to Square is 0.56.
However, the Pearson Coefficient of the Nasdaq to Square of this same period is a very strong .99
Nvidia (NVDA), is another company that has created a chip aimed specifically at mining cryptocurrency.
As a result, NVDA has also become a stock that is being used as a vehicle to gain exposure to Bitcoin.
Bitcoin to NVDA Pearson Coefficient is 0.53
Over the past 5 days, the Nasdaq to NVDA Pearson Coefficient is .99.
Again very strong.
Of course, Nvidia is also a technology company and a part of the semiconductor industry and therefore correlates with the Nasdaq.
Below is a chart of NVDA to Bitcoin.
As shown in the chart above, NVDA directionally has a lot of correlation to Bitcoin, but the Nasdaq is a component of these price fluctuations as well, which is why a direct Bitcoin to NVDA correlation does not tell the whole story.
Traders and Investors will continue to seek alternatives to trading and investing in crypto-currency directly due to security concerns. Their desire for alternative investment options will also be driven by the fact that they require an account with a bitcoin exchange such as a Coinbase.
Some stocks are a big portion of the Nasdaq 100, and since the Nasdaq 100 and Bitcoin are also somewhat correlated, they are not correlated to bitcoin but more so to the Nasdaq. These stocks would be ones to avoid if a trader or investor is seeking exposure to crypto-currency.
Some stocks, despite their strong correlation to the Nasdaq, do have a stronger correlation to Bitcoin.
One such stock at least over the prior 5 days has been Amazon, AMZN.
As you can see from the chart above there is some price correlation to Bitcoin.
The actual Pearson Coefficient between amazon and bitcoin is 0.71, meaning there is a moderate correlation between the two stocks over the past 5 days.
The Pearson Coefficient for the Nasdaq and Amazon is .97.
Again a stronger correlation to the Nasdaq but compared to MSTR, SQ, and NVDA, over these 5 days, Amazon has a stronger correlation to Bitcoin than these other stocks.
Some stocks despite being a big portion of the Nasdaq 100 are not correlated to bitcoin although they may correlate strongly to the Nasdaq. These stocks would be ones to avoid if a trader or investor is seeking exposure to the price action of Bitcoin.
One ETF that was created is the BLOK, short for Amplify Transformation Data S.
Compared to the other stocks reviewed, this ETF BLOK has a Pearson Coefficient of 0.80, showing a strong correlation to Bitcoin over these 5 days.
BLOK still has a .95 Pearson Coefficient to the Nasdaq but also has a very strong correlation to Bitcoin itself.
By doing this analysis, using the last 5 days as a sample, Amazon and BLOK would be two alternative investments with a strong correlation to Bitcoin and Cryptocurrency.
Of course, one can use any time frame to determine the correlation for the trade setup they are seeking, but combining the Pearson Coefficient analysis with other trading lessons taught to our Free RPM Newsletter subscribers traders can better identify alternative Bitcoin and Cryptocurrency investment options.
Combining the Pearson Coefficient with technical analysis taught in RPM Assets newsletters can present opportunities to buy stocks and ETFs that correlate highly to Bitcoin and other ETFs, without purchasing cryptocurrencies directly.