The Basics of Quantamental Analysis
Before entering the digital asset market, investors may consider digging into methods of pricing crypto currencies: technical, fundamental and quantamental analysis. Today, in this note, we will explore how quantamental analysis is applied in the context of digital assets pricing.
Quantamental trading refers to an investment strategy that combines quantitative approaches using computers, mathematical models and big data with fundamental methods. Cryptocurrencies and blockchain datasets are a relatively new and rich data asset class with a public and free access allowing a new form of analysis with no equivalent in other asset classes.
The quantitative metrics used in fundamental methods always focus on financial metrics, competitors and markets to assess the growth potential. A trader needs to combine metrics to make valuable signals within a large universe of digital assets. A buy or sell signal would get wrong in many cases if taken in isolation but it would be valuable if taken as part of a large set of other diversified indicators. An investor would be successful if the signals are valuable in the current market. As different signals might conflict for the same asset at a given time, it is important to weigh them all to get the best possible picture.
Here are some examples of how quantamental can empower a crypto assets investor in new ways:
Fundamental ratios - A trader needs to pick some fundamental ratios and weigh their importance. As developed in the fundamental analysis paper, investors might combine some on-chain, project and financial metrics to get valuable ratios. As an example, you may follow the following ratios:
- Network Value-to-Transaction is a short term ratio showing whether the digital asset is adding or losing relative value; undervalued is <55 & overvalued is >75.
- Cost to mine a bitcoin is a long term valuation ratio seeing mining costs as a support level for bitcoin: miners (main natural crypto sellers) reduce selling when BTC is low, when Bitcoin mining prices rise, the cost of the currency tends to rise as well, creating a bullish trend. Bullish is <1.2 and Bearish is >3.2.
- Daily unique addresses is a relative indicator of the current usage of the digital asset. If the number of unique addresses is increasing, the market is bullish.
- Daily transaction value is a relative indicator of the usage of the digital asset. If the value is increasing, the market is bullish.
Sentiment Analysis - The crypto market behaviour is very emotional. When the sentiment is very bullish, investors tend to buy by Fear Of Missing Out (FOMO) and vice versa, when markets are overwhelmed with fears, investors tend to sell irrationally at cheap prices. Sentiment analysis helps determine whether the market is currently overly bullish or bearish. The strategy is based on extracting trading signals using machine learning algorithms applied to various metrics. Here are some examples of valuable metrics:
- crypto volumes: high buying volumes on positive markets might be a sign markets are too bullish.
- price volatility: when volatility increases, markets may feel more risks.
- social media: unusual increase of hashtags and interests for a cryptocurrency may reveal the market is too bullish.
- google searches: a sudden increase in google searches for a digital asset linked to a negative idea might give an idea of the risk within the general public.
As an example, the Crypto Fear & Greed Index is published as a simple indicator to follow the market sentiment on the major digital assets.
Derivatives indicators - Futures and options are contracts that derive their value from fluctuations in the underlying assets. Derivatives data may not relate directly to fundamental metrics but it is often used as a measure of market sentiment: for example, a trader buying a call option or a future may represent a rather bullish view on the underlying asset. Signals found in the derivative markets may give some clues on how the underlying might move. Investors could follow some of the following data:
- Open interests (OI): represents the total number of derivative contracts on an underlying asset which have not been settled yet. Traders often use OI in conjunction with volume and price levels as indicators to confirm trends and trend reversals. On a general note, increasing volume and OI would confirm a trend while declining volume and OI might end up with a change in the trend. Theoretically, increasing price, volume and open interest indicate that new money is coming in (bullish markets). But, if the price of the asset is rising while volume and OI are on the decline, short sellers covering their positions may be causing the rally: money is flowing out (sign of bearish markets). Also higher open interests often mean higher volatility of the underlying market.
- Another signal to look at is the put/call ratio which indicates the number of sellers vs buyers. If the ratio increases, the market gets more bearish and vice versa. Trading volume in put options is likely to increase before markets prices drop. Trading volume in call options is likely to increase before markets rally.
- Volatility skew is derived by calculating the difference between implied volatilities of options. The relative changes in the volatility skew of an options series can be used as a strategy by options traders. For example, if the skew is moving upward, meaning out of the money calls are more expensive, then the underlying market is bullish.
We only have selected and explained some of the numerous quantamental strategies; ideally you will combine your own selection with other technical and fundamental metrics to better understand the financial health of the crypto assets you would like to trade. The principles of quantamental analysis may therefore guide your investment decisions.
As trading assets as volatile as cryptocurrencies requires mastering technical, fundamental and quantamental analysis, you may as well decide to be less price sensitive and opt for a diversified index, where movements are smoothened by the various assets in the index.
At Trakx.io, we offer Crypto Traded Indices (CTIs) to get an easy exposure to thematic strategies similar to ETFs in traditional finance. Investors need to select the thematic that meets their investment objective and match it with one of our various products, such as Trakx Top10 DeFi (thematic investment), Bitcoin Control 15 (Volatility control) or Trakx Inflation Hedge (smart investing).
Please contact Laurent at Trakx for additional questions.
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