A lightning-paced saga is currently unfolding in Bitcoin’s digital world, which is separate from its contemporaries, as it is dual-purpose and has no time constraints and can operate 24/7. Before anything goes down on Wall Street, the prices of bitcoin provide an adequate gauge as a view into the investor’s mind. The innovative study captures more than just attention, as it highlights price fluctuations that happen during most traders slumber, which are wild signals of important factors and could show strong indicators for sentiment and, at times, could predict stock market volatility.
The Midnight Barometer: Bitcoin’s Overnight Returns and Investor Mood
An eye-catching study conducted by researchers at Xiamen University—School of Economics has explored Bitcoin’s overnight price movements. Their examination reveals a remarkable relationship between these off-hour returns and the behavior of retail investors, exposing an unexpected volatility “predictive” power for contemporaneous traditional markets, particularly the S&P 500. This study contains new possibilities concerning the ways in which the cryptocurrency market dynamics may, in some fashion, affect the shifting margins of risk across different asset classes.
To develop these theories, the researchers systematically worked through U.S. stock market Bitcoin price 5-minute data from CoinAPI for the period January 2018 – December 2023. The dataset was structured and synchronized with US stock market trading hours, that is, 9:30 AM to 4 PM (Eastern Time), to facilitate comparison of Bitcoin daytime and overnight performance.
A Distinctive Form: The Daily Return Reversal
Analyzing profits from Bitcoin through the daily open-to-close breakdown into overnight returns (close to the next market day’s open) and trading hour (open to the next market day’s close) segments reveals distinct patterns, as discussed earlier. On average, overnight returns were found to be 0.093%, while trading hour returns averaged at -0.029%. Such returns demonstrate the phenomenon referred to as “daily return reversal,” meaning any gains accumulated while the markets are closed will be reversed in full or in part during the next trading day.
In seeking to explain the reasoning for Bitcoin’s overnight returns, researchers have used that phenomenon as an indicator of the retail investor’s sentiment. Their theory was that if these overnight movements served as a reflection of retail investors’ sentiments, individual investors, driven by their blended trading emotion as retail investors, would actively participate and would lead to a price surge as off-hours and subsequent pullbacks during working hours (institutional trading hours) would dominate. The pattern was observable in the data and reinforced during periods of intensive investor focus.
Investor Attention: The Force Behind the Overnight Signal
With abnormal gamer-focused attention, Bitcoin returns are grouped, and that provides a new hypothesis that can be tested. It was striking that during periods when attention was high (more search queries and more unique addresses actively using the bitcoin network), overnight returns accompanied by significant return reversals were hugely pronounced in comparison to low-attention periods bringing reverse returns.
As an example, the return overnight spread between periods of high and low attention reached a statistically significant value of 1.133% based on Google Search data, while it was 0.987% using unique address activity. High-attention trading hour return patterns also showed no consistency.
To ensure the accuracy of their findings, the investigators created a composite Google Search Index by performing a principal component analysis on a number of search queries associated with Bitcoin. These different measures of attention returned the same results: returns during the overnight period increased with interest from the investors, while trading hour returns continued to be stagnant.
The results obtained from analysis indicate sentiment-focused price activities in Bitcoin are largely driven by demand during the overnight hours and inversely affected during the following trading day. Bitcoin’s overnight returns offer great potential as indicators of market sentiment on short-term investments in cryptocurrency.
Bitcoin’s Midnight Predictions: Foreseeing Volatility in the Stock Market
The most remarkable finding of this study is perhaps the capability of anticipating volatility in the stock market based on Bitcoin’s overnight returns. Regression analysis showed that overnight returns of Bitcoin are a strong predictor of the change in the VIX—the gauge of volatility based on the S&P 500—yet trading was suspended while it was active in the US.
This predictive power continued to hold concerning SPX futures, holidays, or FOMC announcements, suggesting Bitcoin’s overnight activity is uniquely predictive of upcoming uncertainty in the equity market, not captured by traditional indicators.
These results strongly suggest that Bitcoin’s overnight returns do contain valuable information pertaining to investor sentiment, improving the prediction of VIX movements in historical data (in-sample) as well as forecasting future volatility (out-of-sample). Additionally, the researchers argue that there could be many exploitative trading strategies revolving around VIX derivatives, which makes this unexpected cross-asset relation intriguing and emphasizes the surprising practical relevance of these findings.
A New Portal in Market Psychology
This astonishing study has shown astounding scope in market psychology by connecting overnight movements of Bitcoin to short-term crypto investor sentiment as well as volatility outlooks in equities. Market relationships and their interactions often go unrecognized. As the world continues to change economically, grasping such relationships will be useful for those who wish to understand international markets.
