Rabaa Karaa, University of Sousse, Tunisia
Skander Slim, Dubai Business School, University of Dubai, UAE
John W. Goodell, College of Business Administration, The University of Akron, Akron, OH, USA
Abhinav Goyal, Cork University Business School, University College Cork, Cork, Ireland
Vasileios Kallinterakis, University of Liverpool Management School, University of Liverpool, Liverpool, U.K.
Feedback trading (i.e. trading on historical prices) constitutes a rather popular strategy among investors internationally whose presence has been confirmed at both the micro (for various investor-types, such as retail, institutional and overseas) and macro (using aggregate data) levels and for various market states (including rising/falling prices and regulatory changes) in a variety of asset classes (equities; bonds; derivatives; exchange-traded funds; property; currencies). These asset classes involve instruments bearing fundamental value and evidence from them has demonstrated that feedback trading can be the strategy of choice of both sophisticated investors (who, though aware of fundamentals, choose to rely on past prices motivated by various rational considerations) and noise traders (whose lack of knowledge of fundamentals justifies their reliance on past prices) alike. However, the advent of cryptocurrencies during the past decade has given rise to a novel market segment of ever-growing popularity among investors – and one largely viewed as being of little or zero fundamental value. Although this would suggest the significance of noise trading in cryptocurrencies (something that has been empirically confirmed by several studies), it is interesting to note that very little is known to date about the presence and determinants of feedback trading in the cryptocurrency market.
In this research, we explore whether feedback traders are active in the Bitcoin market and whether a series of noise-related factors (sentiment; volume; liquidity) bear an effect over their presence across various frequencies (hourly; daily; weekly).
We report positive feedback trading (i.e. a trading strategy that implies buying when prices rise and selling when they fall) for the hourly and daily (yet not the weekly) frequencies, The magnitude of positive feedback trading grows the strongest for the hourly estimations, with its significance concentrated for that frequency during major Western exchanges’ trading hours. Our findings suggest that feedback traders in the Bitcoin-market chase rather short-lived trends, possibly due to Bitcoin’s high volatility at those frequencies, as well as due to the profitability-potential of momentum strategies at high frequencies in the cryptocurrency market.
The evidence presented in this study is of key relevance to the investment community, particularly those investors with a focus in the cryptocurrency market. The interactions of feedback trading with several factors illustrated here could serve as inputs for informing their trading strategies at various trading horizons. To the extent that Bitcoin’s market is typified by inefficiencies and positive feedback traders at higher frequencies, this implies the potential for exploiting both (inefficiencies and feedback traders) via ad hoc strategies at those frequencies, e.g. by conditioning one’s trades on anticipated shifts of sentiment or volume. In addition, the presence of positive feedback traders in the Bitcoin suggests the (potentially profitable) exploitation of their trading conduct by rational speculators (e.g. via front-running them prior to the announcement of cryptocurrency-related news). As regards researchers, our findings indicate the need for expanding the pool of studied behavioural influences in cryptocurrency trading by researching additional behavioural factors whose effect has been established in equities and other asset classes. Examples here could include anchoring and the disposition effect, considering that both involve reference points in decision-making (with these reference points often based on past prices, in line with feedback trading). From a regulatory perspective, the presence of positive feedback traders entails the potential for destabilization in the wider cryptocurrency segment; considering the adverse effects this can bear on social welfare (given the wide popularity of cryptocurrencies among retail investors), it is important that regulatory authorities issue regular communications to the wider public, outlining the risks of investing in cryptocurrencies and cautioning against their treatment as lottery-type investments.