Steemit Crypto Academy Contest S16W1 - Cross-Asset Correlation Analysis

Let's imagine that we're on the look for the returns of two different assets, Asset A and Asset B. We can plot the returns of these assets on a chart, and see if they move in a related or contrary direction. For example if we see that the returns of the Asset A and the Asset B tend to go in similar directions, this would be an example of a positive correlation. On the other hand, if we see that the returns of Asset A and B tend to go in opposite directions this would be an example of a negative correlation..

Starting the first week of the Steemit Engagement challenge season 16, here we are presented with a topic - "Cross Asset Correlation Analysis". To explore the concept, below is a well detailed post with tips fully elaborated for easy understanding..

PIXABAYedited using Inshot

From the introduction, a slight spy has been done on the context and what it looks like. Formally, the cross-asset correlation refers to the relationship between the returns of two or more different assets. This concept is very essential in the field of portfolio management, which is the process of picking and handling/managing a collection of investments to meet an investor's individual goals.

Cross-asset correlation can help portfolio managers to understand how the various assets in their portfolio are correlated to each other and how changes in one asset might influence the others. This can help them make more informed decisions about how to organise and manege the portfolio. Moreover, cross-asset correlation can be used to manage and measure risk..

A "Diversified" portfolio is one that contains a mix of various types of assets, such as cryptocurrencies, bonds, and stocks. Understanding the correlation between these different assets is important for a few reasons..

• First, if all of the assets in a portfolio are highly related, then a negative event affecting one Asset could have a big strike on the entire portfolio. However, if the assets are less related, then the impact of a negative event on the portfolio would be less harsh. By understanding, correlations, investors in the market can make more informed decisions about which asset to include in their portfolio and how to view and weight them to avoid severe impact of a negative event on the entire portfolio or vice versa.

In general, Correlations between assets tends to increase during bearish market conditions and decrease during bullish market conditions. During a bear market, many assets tend to depreciate in value, which leads to increased correlations as the proves of different assets move in an identical direction. On the other hand, during a bull market, most assets tend to increase in value, resulting to decreased correlation as the different assets may NOT move in similar directions.

Certainly, there are always exemptions to these general trends, and correlations can change based on the specific assets and market conditions. That being said, these general patterns are worthy of serious consideration when making investment decisions.

One way in which traders can leverage this knowledge is by using it to adjust their trading strategies based on the current/overall market sentiment. For example during a bear market, traders might go for a defensive approach and concentrate on curtailing losses rather than trying to maximize gains. This could involve using stop-loss orders to protect against further decline in the market.

On the other hand, during a bull market traders might choose to take a more competitive approach and concentrate on increasing gains by using techniques such as scaling in and out of positions. There are many other ways to adapt to trading strategies based on the market sentiments.

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The main way that this knowledge can be used for risk management and portfolio diversification is by creating a portfolio that has a mix of negatively correlated, positively correlated and uncorrelated assets. This type of portfolio is often referred to as a "Balanced" portfolio. By including assets with dissimilar correlations, a trader can reduce the overall risk of the portfolio while still controlling the possibility for gains.

For better understanding, if one asset goes down in value, another may go up in value, therefore offsetting the loss. This can help to minimize losses and build up the overall solidity of a portfolio.

One example of how allocating assets with low or negative correlations can help to mitigate overall portfolio risk is the so-called "60/40" portfolio. This is an accepted portfolio strategy that is made up of a 60% allocation to stocks and a 40% allocation to bonds. Stocks and bonds have historically had a negative correlation, so a drop in the stock market is often followed by a rise in the bond market and vice versa. This negative correlation help to balance out the risk of the portfolio as profit or losses in one asset class can be offset by the other.

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Let's take a peep at the historical correlations between STEEM and other major cryptocurrencies. I'll start with STEEM and Bitcoin (BTC), as they are often analyzed because they are both cryptocurrencies.

Over the past few years, there has been a strong positive correlation between the two (STEEM and Bitcoin), meaning when the price of Bitcoin goes up, the price of STEEM usually goes up as well. However this correlation has not been stable, and there have been times where the two cryptocurrencies have diverged from each other. For example, during early 2018, the price of Bitcoin fell while the price of STEEM, remained somewhat stagnant.

This divergence between the price of these two, provides insight into the unique factor that affects the value of each cryptocurrency. Bitcoin is often seen as a "safe haven" asset while STEEM is more closely tied to the achievement of the Steemit Platform and the broader cryptocurrency market. This means that events that affects Bitcoin may not necessarily have an impact on STEEM, and vice versa.

It is very essential to understand that correlations can change over time, so it's not always possible to predict how assets will be correlated in the future. Although, by looking at the historical data, we can see some general trends that may be of use for traders. For example, the years past, STEEM has become more closely correlated with the broader cryptocurrency market. This may be due to the growing popularity of the Steemit Platform and it's thriving role in the cryptocurrency ecosystem. So in general, it can be said that when the overall cryptocurrency market is doing well the price of STEEM tends to do well too.

In general conclusion, cross-asset correlation analysis is a useful tool that can provide well valued insights into the relationship between different assets in the market. By under the historical patterns and trends, traders/investors can make more accurate/informed decisions about their portfolio and possibly improve their complete performance. However it's important to know that cross-asset correlation analysis does not imply accurate applications as correlations can change over time.

Disclaimer: Any information mentioned in the above article as guides or strategies are not to be considered as financial advises as to which I'm no financial advisor. Please do well to make your research and go with right decisions.

Thanks for reading

I invite @emmyjnr, @uduak3287 and @samuelnkenta