Today I'd like to talk about the periodicity of volatility in the bitcoin markets and how it might affect how you place stop orders.
First, it's long been noted that volatility in the equity markets form a U shape throughout the day. Volatility during the market open and close are the highest with a pronounced lull in the middle of the day (some half-jokingly say due to traders taking their lunch). Similarly, intraweek volatility also shows a U shape for many asset classes with Mon and Fri being the most volatile and Wed being the least though this effect is not as pronounced as the intraday effect. Outside of these short term cyclical effects, some traders have noticed an October Effect (a number of market crashes happened in Oct so there may be some psychological effect here) and a January Effect (people dump losing positions for tax reasons in Dec and buy back into the market in Jan) but these effects are related to returns, not volatility, so we will not focus on them.
So it begs the question, do the bitcoin markets display periodicity in return volatility too? Some traders on TradingView have found that large price moves often happen during and slightly before the New York and London open and closes. If that's the case and if your trading strategies have a timeframe longer than a single day, it might help your risk management processes to factor out this persistent and periodic noisiness in returns during those times. For example, if you believe bitcoin will go up over the next few days but you also want some downside protection in case you are wrong so you place a trailing stop 3% below the current price, you don't want random noise due to these New York and London "kill zones" to stop you out of your position when your trading idea over a longer timeframe was sound and the general market trend agrees with you. Rather it would be better to have a dynamic stop which periodically adjusts for the extra volatility during these kill zones by going proportionally wider below the then current price during those specific times. The longer the timeframe of your trading strategy and the closer you want to put your stop next to the current price, the more important this concept becomes. If your timeframe is longer than a week, it might also help to apply this concept to intraweek periodicity (e.g. weekends are less volatile than weekdays).
Outside of managing risk in trading the underlying, once options markets develop in bitcoin, understanding the periodicity of volatility will help options market makers know when to widen their quotes and by how much, which can directly lead to less adverse selection and subsequently greater profits.
References:
- Intraday volatility in FX and equity markets: http://public.econ.duke.edu/~boller/Published_Papers/joef_97.pdf
- Bitcoin Kill Zones: https://www.tradingview.com/v/zZYED4fH/
Cheers,
Kevin & Team Buttercoin
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