Understanding The Cryptocurrency Market Cycle

Disclaimer: There has been a consistent attempt by the author to separate the definitions of “investor” and “speculator”. While some people may assert that no purchase of cryptocurrency can be classified as an “investment”, the author has decided in the context of this article that a buyer of cryptocurrency assets is an “investor” if he/she first considers widely and objectively the asset in question compared to the current price and surrounding market sentiment. An Introduction To Cycles We’ve all heard of market bubbles. Even though there are a wealth of lessons to be learned from past bubbles it seems that market participants are destined to get sucked in each time a new bubble emerges. A bubble is only one of many stages of the market cycle, and to avoid being caught off-guard, it is essential to know what the different phases of the market cycle are. An understanding of how markets work and how cycles develop, combined with emotional fortitude and perseverance will help you stay safe trading and investing in the cryptocurrency markets. What Makes A Cycle? Cycles span across all aspects of our lives. They come in many different forms and range from the very short-term, like the life cycle of an insect, to the cycle of evolution which takes millions of years to make even the tiniest of changes. It does not matter which market you are referring to, they all go through the same cyclical stages, why? Because they all have one thing in common— human involvement. Economist Amos Tversky and psychologist and Nobel prize winner Daniel Kahnemann were the first to challenge the accepted theory that humans were above all rational decision makers and as such the financial markets were an accurate reflection of all currently available price information. By doing this they pioneered the field of behavioral economics and have gone on to publish their theories and studies on systematic errors in human decision making. The root of these errors in judgment stem from cognitive biases, including loss aversion, recency bias, anchoring as well as the emotional tugs of fear and greed. As a result of these emotional biases, most investors and traders fail to recognize that markets are cyclical, or are simply cannot control their emotions when they need to the most. Another inherent challenge is the egotistical need for traders to “pick” the top and bottom which is almost impossible to actually do consistently. Therefore, simply understanding that cycles exist is not “the magic bullet”. You also need to be able to evaluate and make calculated decisions around where we stand in the current cycle and control your emotions if you want to maximize your investment or trading returns. 1. Accumulation Phase — Think Crypto Mid-2015 This phase occurs after the market has finished bottoming and come down from a previous high. Early adopters, innovators, experienced traders, and smart money managers begin to buy, figuring the worst is over and their downside is limited. They understand that it is unlikely they will be buying at the exact bottom, but they can see a favorable risk/reward trade. At this phase, valuations are very attractive, the general market sentiment is bearish and the majority of investors are unable to foresee any positive developments. Those who were holding on through the majority of the bear market have recently given up and sold out the rest of their holdings (this is the “capitulation” stage you may have heard referred to). The end of the depression stage and the beginning of the accumulation stage is typified by: General disinterest Subsiding anger A tightening of capital investment General negative sentiment and the inability to believe positive developments are possible Complete risk aversion In the accumulation phase prices have flattened out, the markets are boring and for every seller that is throwing in the towel, new investors, or old investors that sold higher up are starting to buy. The overall market sentiment begins to switch from negative and angry to neutral and bored. 2. Mark-Up Phase — Think Crypto early 2017 The market has been stable for a while and prices are generally starting to pick up. It is hard for the market to make any real price increases because every time the price moves higher, there are still sellers there to halt the advance. More early adopters start to get on the bandwagon. This group often includes technical traders seeing that the market is putting in higher lows and recognizes the trend has changed. Then the media piles on and starts to discuss the possibility that the worst is finally over. Towards the later phase of this stage of the cycle, speculators start to come back to the markets, seeing the rise in prices and the anticipation of further price increases the fear of the market is supplanted by greed and the fear of missing out. 3. The Top — Think Crypto late 2017 This phase is typified by: Inability to perceive negative outcomes Belief the price will rise indefinitely The idea that “this time was different” Excessive capital investment in speculative positions Extreme risk tolerance This stage of the cycle begins by the mainstream majority starting to dip their toes in the market. The media starts the printing press for an endless stream of bullish articles (late to the party as always, thanks, CNBC). Recency bias starts to take over and investors start to agree that price increases are to be expected. The fear of missing out starts to attack the will power of those that haven’t invested and are trying to resist the temptation of the markets. As a result, valuations climb well beyond historic norms, logic and reason take a back seat to greed, and the simple act of participating in the market begins to feel euphoric. During this time smart money and insiders start to unload their positions, with the increased volume and demand they don’t have any trouble selling without influencing the price. They understand that the market has become overvalued and that the top is coming soon. Investors come to believe they are invincible and as a result, start to take on greater and greater risk demanding less guarantee of safe returns for their capital and hence engaging in riskier ventures. Prices make one last parabolic move and sentiment moves from bullish to downright euphoric. When the last investor decides that “it’s different this time, the future is bright and asset valuations will continue to rise indefinitely” the climax is reached. 4. Distribution Phase — Think Crypto Early 2018 In the fourth phase of the cycle panic and sellers dominate. The early part of this cycle is identified by a period in which bullish sentiment starts to be questioned for the first time since the beginning. There is often an extremely sharp sell-off, followed by a sharp bounce as market participants begin to agree that “the market needed correction before it could resume its bullish trajectory”. However, the rally never reaches the previous all-time high and as the price starts to drop for a second time, the panic really starts to kick in. Technical charting patterns like double and triple tops, head and shoulders patterns and dead cat bounces are all examples of movements that occur during the distribution phase. The distribution phase is a very emotional and volume heavy stage of the market cycle, as investors that came in early are gripped by indecision, unsure if selling out and taking profits was the right move. At the same time, those that came late, and bet big are overcome by the fear of losing it all interspersed with hope and greed to recover losses as the market intermittently appears to take off again. Investors are trying to decide if there will be a new level of valuation that can hold up at these extremely high levels as market participants still cling to their ideas of a new paradigm. The speed of this phase is almost always different. Sometimes sentiment can swing in a matter of weeks, sometimes it takes months and sometimes even years as fundamental factors move into place. Usually, the more extreme the high, the sharper and faster the fall. Those who are unable to sell for a profit settle for a breakeven price or a small loss. 5. Mark-Down Phase — Think Crypto 2018 This stage of the market cycle hurts. New investors and traders that have not been through a complete market cycle are usually the ones hit the hardest, as they continue to hold onto their positions at a great loss. Many hang on because their investment has fallen below the amount they paid for it after getting caught up in the euphoria and are now trapped. When the market plunge reaches the 50% level or more, the laggards, most of whom bought during the distribution and early markdown phase give up, throw in the towel and capitulate. Unfortunately, this is a buy signal for the early investors that made healthy profits and are now sitting on the sidelines. Alas, they are usually burned with this second attempt at investing as the market continues down and moves into the anger/capitulation and finally depression stage of the cycle. The Cryptocurrency Markets Today So, where are we now? It is impossible to know for sure, everything we know now is speculation and cannot be guaranteed. There are a number of factors at play that we can observe and analyze in an attempt to form objective and rational judgments. It appears that we sit around the start of the depression stage of the cryptocurrency market cycle. The markets are boring, there is a disinterest with cryptocurrency generally, the anger has recently subsided, there is a tightening of capital investment, high levels of risk aversion and negative market sentiment creeps into all aspects of the discussion. When these factors are present it is very difficult for the market to make any real upward movements. This is because as soon as it does, those market participants start to remember the recent times they were burned, they become too nervous to hold their money in the markets, and they withdraw their investment at a small profit or break even to avoid any losses. This is a complete contrast to the bull market of late 2017 when investors could not foresee any risk or possible negative outcomes, believed the price would rise forever, agreed that “this time is different”, invested excessive amounts in speculative positions and showcased extreme tolerance to risk. You can begin to see that these two market states are a very long way from each other. The jump between them is not a quick step, it is a slow cyclical movement. So far, it has taken us 14 months to get to where we are right now and it would, therefore, be safe to assume that it would take a minimum of 14 months (often times the recovery period is 2–3x that amount of time) to return to a positive and optimistic state. This smaller cycle of sideways movement will play out a number of times within the larger cycle until there has been a large enough increase in price for people to begin thinking “maybe this rally will be different” and instead of selling out early, they hold on a little longer, just to see what happens. As simple as that, we transition from the accumulation phase to the markup phase. Right now is the first time in years that there are actual bargains available compared to historic price levels. At all times investors are constantly calculating the risk and reward of taking action or refraining from taking action. Right now we are at one of those crucial points in time where you need to ask yourself a series of questions to determine one single calculation. Is the risk of investing now equal to or greater than the risk of not buying? **************************************************************** This article was written by Boss Cole. 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