An “abnormal return” refers to the difference between the actual return on a cryptocurrency investment and the expected or normal return based on various factors, including market trends, historical performance, and risk assessments. It’s a way to measure how a cryptocurrency’s price movement deviates from what would typically be anticipated.

How an Abnormal Return Works

• Expected Return: To calculate an abnormal return, you need to establish an “expected return” or a predicted return. This expected return is typically determined through analysis and assessment of the cryptocurrency’s fundamentals, market conditions, and any relevant information. It’s essentially your best estimate of how the investment should perform.

• Actual Return: The “actual return” is the real return you earn or lose on your cryptocurrency investment over a specific time frame. It’s the actual profit or loss you experience during that period.

How is Abnormal Returns calculated?

The abnormal return is calculated as follows:

Abnormal Return = Actual Return – Expected Return

The result of this calculation, the abnormal return, provides insight into how your cryptocurrency investment performed relative to your initial expectations. If the abnormal return is positive, it means your investment outperformed your initial predictions. Conversely, if it’s negative, it indicates that your investment underperformed.

For example, if you expect a cryptocurrency to generate a 10% return over a certain time period, and it actually yields a 15% return, you have a positive abnormal return of 5%. This suggests that your investment performed better than you anticipated.

Conversely, if the expected return is 10% and the actual return is only 5%, you have a negative abnormal return of -5%, indicating that your investment underperformed relative to your expectations.

Abnormal returns can be valuable in assessing the effectiveness of investment strategies and understanding how external factors, such as news, events, or market conditions, influence a cryptocurrency’s performance. It helps investors and analysts gauge the impact of these factors and make more informed investment decisions in the often highly volatile and unpredictable world of cryptocurrencies.

Usage of an Abnormal Return

• Event Analysis: Abnormal returns are frequently used to assess the impact of specific events or news on cryptocurrency prices. For example, if a regulatory change or a significant partnership announcement results in abnormal returns, it indicates that the event had a notable effect on the cryptocurrency’s performance. This can be valuable for understanding how external factors influence price movements.

• Strategy Evaluation: Investors and traders often employ abnormal returns to evaluate the effectiveness of their trading or investment strategies. If a strategy consistently generates positive abnormal returns, it suggests that the strategy has been successful. Conversely, negative abnormal returns may prompt a reassessment of the chosen approach. It provides a quantitative way to gauge strategy performance.

• Risk Assessment: Abnormal returns can be used to assess the risk associated with a particular cryptocurrency. If a cryptocurrency exhibits high levels of abnormal returns, it may signal greater price volatility, which can be a consideration for risk-averse investors.

• Market Anomalies: Abnormal returns can help identify market anomalies or irregularities. By analyzing historical price data, analysts can uncover patterns where certain cryptocurrencies consistently generate abnormal returns during specific market conditions. This information can be useful for opportunistic trading strategies.

• Portfolio Diversification: For those managing cryptocurrency portfolios, understanding abnormal returns can assist in diversification. A diversified portfolio aims to minimize risk, and abnormal returns provide insights into which cryptocurrencies may offer low correlation with others, potentially reducing portfolio volatility.

• Investment Decision-Making: Cryptocurrency investors can use abnormal returns as part of their investment decision-making process. Positive abnormal returns may attract attention as potential investment opportunities, while negative abnormal returns may warrant caution.

• Benchmarking: Abnormal returns can be used to compare the performance of different cryptocurrencies or portfolios to benchmark indices or other reference points. This helps investors gauge how well their investments are performing relative to the broader market.

• Backtesting: Traders and analysts can use abnormal returns in backtesting to assess how a particular trading strategy would have performed historically. This can inform the development of more effective trading strategies for the future.

Ultimately, abnormal returns in the crypto market are a versatile tool that can assist with event analysis, strategy evaluation, risk assessment, and investment decision-making. They provide valuable insights into the performance of cryptocurrencies and can aid traders and investors in optimizing their approaches to the market.