Market bubbles can exist in all kinds of markets and since the 2008 financial crisis, it has become household terminology. Famously, that crisis stemmed from irresponsible banks loans and a housing market bubble.
The wealth of lessons that can be learned from looking at past market bubbles appears to have little effect on people being sucked into the latest bubble. There is something too attractive about being able to jump in on an opportunity to make money quickly.
But a bubble is only one of many stages in any market cycle. It is essential to know what the different stages of market development are in order to make sound decisions without allowing your emotions to run away with you and to avoid being caught off-guard.
Defining A Cycle
It is inevitable that every market will have some cyclical stages because of one key thing in common- human involvement.
Humans bring with us an array of emotions. We are not robots that consistently make a decision based on algorithms or logic.
Psychologist and Nobel prize winner Daniel Kahneman and economist Amos Tversky pioneered the field of behavioral economics through their research that contradicted the previously assumed notion that humans are above all rational decision makers. They have since gone on the public their theories and studies on systemic errors on human decision making, the root of being cognitive biases.
These emotional biases are precisely why no one can control the presence of cycles. Investors and traders have repeatedly failed to understand this- when emotions are high we have a hard time controlling ourselves.
The other big challenge causing cycles is the egotistical need for there to be a top and bottom pick, something controlled by or given advice on by top traders. It is nearly impossible to pick these things consistently. Decisions, even by the best, can be made with feelings in mind as well.
Knowing that cycles exist is only half the battle, the other half is being able to evaluate with a clear head and attempt to take control of your emotions.
This is the phase when a market stops bottoming out from a previous high and buyers (innovators, experienced traders, money managers, and early adopters) start coming back. In terms of cryptocurrency, this calls to mind the mid 2015s. Investors pool in the market because they assume the worst is over and that although they aren’t buying from the exact bottom, the risk to reward is too favorable to ignore.
Valuations look more attractive in this phase and the majority of those who held on through most of the bear market have since relinquished their holdings through selling.
The end of the depression and beginning of accumulation is identified by these 5 occurrences: general disinterest, subsiding anger, tightening of capital investment, general negativity and lack of belief in a positive future, and complete risk aversion.
This accumulation phase is full of investors who may have sold at the height of the market and are buying shares back from people who could not stand to stick it through the lower half, with sentiment switching from negative and angry to something more neutral and boring.
Phase Of The Mark-Up
Prices are slowly rising but any extreme height is halted by sellers looking to cash out for fears of it dropping again. Real price increases are not possible because of this. You can see evidence of this in cryptocurrency in early 2017.
The longer stability of the market has encouraged more early adopters to join. The media starts to recognize the changing trend and they start hypothesizing that the worst is over.
Speculators begin to trickle back to the market during the later phase of this cycle, anticipating further price increase after closely watching trends and concerns over missing out.
The Top Of The World
This stage has 5 important factors: Overly positive outlook, belief that the price will continue rising, “this time will be different”, excessive capital investment, and extreme risk tolerance. It begins by the mainstream majority beginning to invest and media producing an endless stream of bullish articles on its positive outlook.
Bias results in investors unanimously deciding the price will continue to increase. Emotions are high and the fear of missing out really starts to take hold during this stage of the cycles. Smart money sees the lack of logic happening and realizes that the top is soon coming and they start to sell. Investors take greater and greater risks and pricing takes one last jump leading to a feeling of euphoria.
Climax has been reached when all investors think it’s different this time and this could rise indefinitely. This peak happened in late 2017.
This phase is aptly named. Cyclic panic sets in and sellers dominate with bullish statements being questions, in the beginning, you can see this reality at the beginning of 2018.
The sharp sell-off leads investors to believe there needs to be a market correction in order for prices to go back up to the high but it never happens and a second dip begins.
Early investors are gripped with indecision, the market is flooded with people and emotions, and the fear of losing it all really starts to set in. The speed of this phase varies with sentiments singing in a matter of weeks and other times taking months. Usually, extreme highs result in sharp and fast falls.
People who are unable to profit end up settling to breakeven and absorb a small loss.
This stage represents nearly all of 2018. It is the painful, hope are dashed, pricing markdown phase. Positions by new investors get held onto through great loss because they bought in at market height.
When market plunge hits 50% or higher, those from the early markdown and distribution phase tend to give up at this moment. The anger and depression stage of the cycle finally sets in.
Cryptocurrency Markets Today
Nothing is guaranteed with investing. There is currently a lot of speculation on the futures of cryptocurrency.
Despite it no longer being a bull market or being in the part of the cycle where it seems like one, 2018 still saw a lot of people investing and investment firms being created. The overall trend of bitcoin for the last decade, for example, shows that although it has a bearish bubble and bust market trend, there has still been a steady incline.
Capital investment has tightened and the market has of course not recovered to the “glory” days of 2017.
It will take a number of times of this happening before people realize they don’t have to sell just because the market is volatile. Investors will have to watch cryptocurrency repeatedly crash and recover while keeping to a steady incline in value for there to be a trust resulting in the belief and reality that cryptocurrency is here to stay.
There is one thing we know for sure, all of us need to be prepared to control our emotions and ask ourselves question that will help us determine if the risk of investing is greater or equal to the risk of not buying.