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Looking at the Bitcoin graph, and that of the stock market, including the Dow Jones and the S&P 500, you may have noted an interesting similarity. The stock market was growing to new heights rapidly, with even Donald Trump tweeting how it had risen 20 percent since his election. A little before these heights, Bitcoin had also surged up to its all-time high of $20,000 on Dec. 17.
Both markets then started to plunge, first, it was Bitcoin, whose price steadily dropped towards $6,000 before hitting a floor. The stock market fell a lot quicker, but the pattern looked remarkably similar, with them both finding a floor last Monday. The Dow Jones Industrial Average saw its biggest one-day point drop in history on Monday, and the S&P 500 had its worst day since 2011. Questions then started to spring up whether or not there was a correlation between the vastly different assets. And can we predict the future moves?
What happened to the Stock?
To determine if there is a correlation, one needs to address the reasons why the stock market is down and investors are seemingly selling off. John F. Wasik, behavioral finance Forbes columnist lists a couple of reasons why the Stocks have crashed. He believes that the general stock market was overpriced, and uses a gauge by Robert Shiller, a Yale economics professor, to assess that. He adds that volatility has returned, looking to the VIX index, and this is important in looking for the Bitcoin correlation.
Furthermore, interest rates are rising and there is a belief that inflation may be on its way back. What happens next? According to Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics, the computers (which make 90 percent of deals on the stock market) make their turn, calculating that even higher inflation is inevitable.
And why Bitcoin took a dip
These explanations as to why the stock market crashed are vastly different to the reasons why it was assumed that Bitcoin fell by almost 70 percent. The problem for Bitcoin, following an expected correction once it hit $20,000, was that there was a stream of damaging media reports, some of them unfounded and simply incorrect.
The confusion firstly in South Korea about a potential ban did its damage before it was eventually cleared up by the South Korean Government. Then, China announced it would be putting one more nail into Bitcoin’s coffin within the country by placing a firewall up to restrict foreign access to exchanges. There was even news out of India that was flagrantly misinterpreted, also regarding a potential ban, that saw Bitcoin plummet.
From these external events, there is no discernible relationship as to why the Bitcoin market and the Stock market fell at the same time. But looking deeper in terms of correlation graphs, you can see some sort of link.
Z-scores and fear gauge
One area of data which seems to show a sort of correlation is in a matrix of z-scores and p-scores. These correlation graphs are quite confusing, but the just of it is that if two assets share a z-score that is negative or positive, there is evidence of either a direct or inverse relationship.
In the graph below, the numbers are called z-scores. They represent the direction and strength of the relationship between the two sets of data. A higher absolute z-score means greater correlation, while a lower absolute z-score means less of a correlation.
A simple glance at this correlation graph can show that the relationship between Bitcoin and S&P 500 is at a weak positive relationship. But, the correlation between VIX and Bitcoin -0.31 making it a moderate negative relationship.
The VIX is a so-called ‘fear