Data Challenges DXY Correlation to Bitcoin Rally and Correction Task

by · September 16, 2022

Currently, there seems to be a general assumption that when the US dollar appreciates against other major global currencies, as measured by the DXY index, the effect on Bitcoin (BTC) is negative.

Traders and influencers have been issuing warnings about this inverse correlation, and how any reversal of the movement is likely to push the Bitcoin price higher.

Analyst @CryptoBullGems recently reviewed how the DXY index looks overbought after its relative strength index (RSI) crossed 78 and could be the start of a pullback for the dollar index.

Also, technical analyst @1coin2sydes presents a bearish double top formation on the DXY chart, while Bitcoin is simultaneously forming a double bottom, a bullish indicator.

The correlation changes over time, despite the general inverse trend

The periods of inverse movements between Bitcoin and the DXY index have never exceeded 36 days. The correlation calculation ranges from a negative 1, which means that selected markets move in opposite directions, to a positive 1, which reflects a perfect and symmetrical movement. A difference or lack of relationship between the two assets will be represented by 0.

Dollar Index DXY 20-Day Correlation Against Bitcoin. Source: TradingView

The metric has been below negative 0.6 since August 19, indicating that both DXY and Bitcoin have generally followed a reverse trend. In fact, the longest period of inverse correlation has been April 14 to May 20.

To say that Bitcoin has an inverse correlation to the DXY index would be statistically incoherent since it had a negative 0.6 or lower on less than 30% of days since 2021.

The dollar strengthened after the FOMC minutes

On August 17, US Federal Reserve officials indicated that further rate hikes would be necessary until inflation slowed significantly, according to the minutes of the July 27 meeting.

Dollar index DXY (orange, right) vs. Bitcoin (blue). Source: TradingView

The report saw the US dollar strengthen against major global currencies as the market gave the Fed a vote of confidence. Meanwhile, Bitcoin fell 11% in two days to $20,800, reinforcing the inverse correlation thesis.

However, a correlation does not imply causation, which means that it is impossible to conclude that DXY’s positive performance negatively affected the Bitcoin price after the minutes of the Federal Reserve meeting were released.

Correlation should not be used to predict short term moves

Although pundits and influencers often use 20-day correlation data to explain daily price movements, one should analyze a longer time frame to understand the potential effects of the DXY index on Bitcoin price.

Dollar Index DXY (orange, right) vs. Bitcoin (blue), 2021. Source: TradingView

For example, 2021 presented some positive correlation between the DXY dollar index and Bitcoin. Perhaps some of the moves were expected by both sides, but no extended periods of inverse correlation were present.

More importantly, events solely relevant to the cryptocurrency may have skewed the calculation, such as the launch of the first US Bitcoin exchange-traded fund on October 19, 2021. Other examples include Tesla announcing a $1.5 billion Bitcoin investment 8 .February 2021.

Additionally, analysts point to the May 2021 Chinese mining crackdown as the reason for the market decline below $40,000. These events could not have been predicted by the DXY Dollar Index, so any ongoing correlation may have had little impact during these periods.

Consequently, those waiting for a reversal of the DXY index before placing bets on a Bitcoin rally have no statistical support. Whenever positive (or negative) developments specific to the cryptocurrency industry take place, the historical correlation loses relevance.

The views and opinions expressed herein are solely those of author and do not necessarily reflect the views of Cointelegraph. Every investment and trade involves risk. You should do your own research when making a decision.