27 Feb 2013 | Forex

In Part 1 of this series, we discussed how bitcoins increased volatility gives traders free trading leverage versus EURUSD. In this article, we dive into the details on how bitcoin volatility has changed over time and other patterns that have developed over the past year.

Bitcoin Volatility: Its Increasing

While EURUSDs monthly price volatility (as represented by standard deviation) has remained in the relatively low 0.5% to 2.0% range since January 2012, BTCUSD has experienced monthly price volatility of 1.0% to 14.0%! Bitcoin volatility in the first six months of 2012 was relatively low, with standard deviation averaging $0.34 and ranging from $0.07 to $0.85. In the second half of 2012, volatility more than doubled, averaging $0.79 and ranging from $0.32 to $1.40. As most readers have witnessed, volatility has continued to increase in 2013. Much of this is do to the fact that bitcoins price has increased nominally over time, but the standard deviation in percentage terms has increased as well. Monthly standard deviation averaged 6.2% in the first half of 2012, 7.4% in the second half of 2012 and 13.4% in January 2013. The chart below displays how the standard deviation of bitcoins price has varied over time. Is this upward trend sustainable? To know the answer, we must understand the causes of bitcoin volatility.

At first glance, monthly standard deviation doesnt appear to have any discernible pattern. As we dug deeper, though, we discovered that standard deviation is strongly correlated to trading volume, with a correlation coefficient of 0.6. This confirms what we would expect that bitcoin price is inherently tied to the aggregate market demand for bitcoin. The next chart below shows how closely volatility moved in line with trading volume.

It is also interesting to note that volatility increased substantially in January, far above what the months trading volume would imply. We believe that much of this heightened market demand for bitcoin has been generated by increased publicity for bitcoin companies in the media, and to a lesser extent, a wider comfort and familiarity with the currency.

As a corollary to our finding that standard deviation is linked to trading volume, bitcoins implied leverage over EURUSD is also related to trading volume. As the chart below demonstrates, implied leverage moves in line with trading volume, translating into a positive correlation of 0.5 over our sample period.

Surprise! The Days You Trade On Can Impact Your Returns

One of the coolest takeaways we discovered is that average returns have varied substantially by the day of the week. In other words, certain days of the week appear to provide better returns than others, and theres a 0.5 correlation between the two items. According to our analysis, if you wanted to go long on bitcoin, your returns would have been higher by trading on Wednesdays and Thursdays. If you wanted to short bitcoin, your best bet would have been to trade on the weekend–Saturdays and especially Sundays. Given the high variance in returns between days of the week and the strong correlation coefficient, we believe there may be an arbitrage opportunity present here.

By the way, the average daily return for bitcoin was 16.5x higher than the average daily return for EURUSD, and they were essentially uncorrelated.

In Conclusion: Win By Making Friends With Volatility

In these articles, we have laid out results that we believe make bitcoin a compelling alternative to traditional forex currencies. By simply switching to bitcoin, a trader can achieve higher leverage while lowering his or her interest expense. We also found evidence of arbitrage opportunities that we believe are currently present in the bitcoin market. If you trade forex and still havent tried bitcoin, we think its time you ask yourself why?