Introduction
A recent study examined how retail investors trade cryptocurrencies compared to traditional assets like stocks and gold. The study focused on the price volatility of cryptocurrencies and the different investment strategies that investors use. Unlike traditional markets, cryptocurrency trading is mainly done by retail investors. This study used data from eToro, a large international retail discount brokerage, to understand these trading behaviors.
Study Setup
The study analyzed data from 200,000 individual retail accounts on eToro from 2015 to 2019. eToro allowed trading in both cryptocurrencies and traditional assets, providing a unique setup to compare trading behaviors while keeping individual preferences constant. By focusing on both asset classes, the study aimed to uncover any distinct patterns and strategies that investors employ when trading in these new and traditional markets.
Trading Strategies
The study found a significant difference between how investors trade cryptocurrencies and how they trade stocks and gold. Retail investors tend to sell stocks and gold when prices rise, but they hold onto their cryptocurrency investments even after large price changes. This suggests that investors follow a momentum-like strategy in cryptocurrencies, while they are contrarian in stocks and gold.
Momentum-Like Strategy in Cryptocurrencies
In the context of cryptocurrencies, a momentum-like strategy means that investors tend to buy more when prices are rising and hold onto their investments even during significant price increases. This behavior contrasts sharply with traditional asset trading, where investors typically sell when prices rise to lock in profits. The study showed that even during large price movements, retail investors did not actively rebalance their cryptocurrency portfolios, indicating a strong belief in the long-term value and potential of these assets.
Contrarian Strategy in Stocks and Gold
For stocks and gold, the study found that investors generally adopt a contrarian strategy. This means that they sell assets when prices increase and buy when prices decrease, expecting a reversion to the mean. This behavior is consistent with traditional investment wisdom, where buying low and selling high is the goal. The study’s findings suggest that retail investors apply this traditional strategy to stocks and gold but not to cryptocurrencies.
Key Findings
- Investor Behavior: Investors hold onto cryptocurrencies despite large price swings, indicating a momentum-like strategy. In contrast, they actively rebalance their portfolios by selling stocks and gold when prices rise.
- Consistent Across Investors: The same investors exhibit different trading behaviors for different asset classes, suggesting that the behavior is asset-specific and not due to individual characteristics.
- Attention and Fees: The study ruled out inattention and trading fees as primary reasons for these differences. Investors actively manage their stock portfolios but not their cryptocurrency holdings.
Detailed Analysis of Investor Behavior
The study provided a comprehensive analysis of investor behavior, focusing on how different strategies are applied across asset classes. By analyzing trading data, the researchers were able to identify distinct patterns that highlight the unique nature of cryptocurrency trading.
Consistency Across Investor Demographics
The study’s results were consistent across different investor demographics, including age, gender, and financial experience. This consistency suggests that the observed trading behaviors are not driven by specific types of investors but are instead related to the characteristics of the asset classes themselves.
Data Analysis
The study focused on the 200 most traded stocks and the three most traded cryptocurrencies (Bitcoin, Ethereum, and Ripple) on eToro. It examined day-to-day changes in the total portfolio share of these assets. By grouping data into cohorts, the researchers reduced noise and better analyzed trading behaviors.
Methodology
To ensure accurate results, the study used a rigorous methodology that included regressing the logarithm of the day-to-day change in the total portfolio share of a given asset on both contemporaneous and lagged returns. This approach allowed the researchers to control for various factors and isolate the effects of trading strategies on portfolio performance.
Cohort Level Analysis
Grouping data by cohorts based on characteristics such as age, income, and trading activity helped reduce noise and provided a clearer picture of trading behaviors. This method is similar to sorting individual stocks into characteristic portfolios in asset pricing tests, which is commonly used to reduce the impact of idiosyncratic noise on parameter estimates.
Potential Explanations
Several factors were considered to explain why investors follow a momentum-like strategy in cryptocurrencies:
- Lack of Experience with Crashes: Before 2018, investors had not experienced a major cryptocurrency crash. Even after the 2018 crash, investors did not change their momentum-like strategy.
- Lottery-Like Assets: The study examined if investors treat lottery-like assets differently but found only a small effect.
- Cash Flow Information: Unlike stocks, cryptocurrencies do not provide regular cash flow news, which might affect how investors update their beliefs about prices. Investors trade contrarian around stock earnings announcements but not in cryptocurrencies.
- Trading Fees: Higher trading fees for cryptocurrencies might make investors hold their positions longer, but the study found that fees are not the primary reason for the observed behavior.
Lack of Experience with Crashes
The first major cryptocurrency crash occurred in early 2018, when Bitcoin’s price fell by about 65% over four months. The study analyzed trading behavior before and after this crash to determine if the experience changed investor strategies. Surprisingly, the momentum-like strategy remained unchanged even after this significant price drop, suggesting that investors’ beliefs about the long-term value of cryptocurrencies were not shaken.
Lottery-Like Assets
Cryptocurrencies are often compared to lottery-like assets due to their high volatility and potential for huge returns. The study investigated whether this characteristic influenced trading behavior. While there was a small effect, it was not significant enough to explain the overall momentum-like strategy observed in cryptocurrency trading.
Cash Flow Information
Regular cash flow information, such as earnings announcements for stocks, provides investors with opportunities to reevaluate their beliefs about an asset’s value. The study confirmed that investors trade contrarian around these announcements, but this dynamic is not present in cryptocurrencies, which lack regular cash flow news. This absence may lead investors to rely more heavily on price movements to inform their trading decisions.
Trading Fees
Cryptocurrency trading often incurs higher fees than stock trading, which could theoretically influence investors to hold their positions longer to offset these costs. However, the study found that trading fees were not a primary factor in the observed differences in trading strategies. For example, even when eToro removed trading fees for stocks in some countries, there was no significant change in trading behavior.
Conclusion
The study demonstrated that retail investors use different models for updating their price expectations for cryptocurrencies compared to stocks and gold. While they adopt a contrarian strategy for stocks and gold, they follow a momentum-like strategy for cryptocurrencies. This behavior is consistent across different types of investors and is not driven by individual characteristics, inattention, or trading fees. Instead, it appears that investors believe that positive returns in cryptocurrencies increase the likelihood of future adoption, leading to an amplification effect in prices.
Implications for Investors
Understanding these distinct trading behaviors can help investors make more informed decisions when trading different asset classes. Recognizing the momentum-like strategy in cryptocurrencies may encourage investors to adopt more diversified and balanced approaches to their portfolios, potentially mitigating the risks associated with extreme price volatility.
Future Research
The study opens the door for further research into the unique characteristics of cryptocurrency markets and their impact on investor behavior. Future studies could explore the long-term effects of market maturation on trading strategies and whether these momentum-like behaviors persist as the market evolves.
Final Thoughts
The insights gained from this study highlight the importance of considering the unique attributes of different asset classes when developing investment strategies. By understanding how retail investors trade cryptocurrencies differently from traditional assets, investors and financial advisors can better navigate the complexities of modern financial markets and make more strategic investment choices.
