By Rainer Franz
As we are well into the cryptocurrency market bear cycle coming into this new year it is a fitting time to look back and analyse why many late and inexperienced investors lost money in this market and to make some simple suggestions on how to go forward in 2019.
This crypto boom was unlike parabolic cycles in other asset classes with regards to the amount of mainstream media coverage it attracted and interest it generated from a younger demographic new to financial markets. The allure of a technical revolution, the libertarians dream of decentralised finance, as well as being labeled as, “the greatest invention since the internet” made for an enticing marketing package. This allowed the market to see multi- thousand percent gains in the course of a year. As the prices reached their heights, it became harder to justify an 800 billion US dollar market capitalisation based on an ecosystem of highly technical and unscalable blockchains not yet ready for mainstream adoption. The market lost buying pressure and eventually imploded. While I am fundamentally bullish on the cryptocurrency market in the long term, the following are the main reasons I’ve identified as to why new investors became trapped by this explosive crypto boom and bust.
My hypothesis is that the average investor in the crypto bull run lacked a comprehensive enough investing methodology to prepare them for the contingency of a market capitulation. Investments were placed almost entirely on the perceived fundamental value of their chosen coin due to persuasive marketing campaigns while investors had a very limited technical understanding of the market cycle. This made them susceptible to their emotions when the market truly started dropping and they weren’t prepared for it. While experienced investors were exiting the market in late 2017, retail investors were being sold on the idea of “HODLing” their portfolios. This was the notion of long term investing in the fundamental value of a cryptocurrency promoted by various community forums and social media influencers. The average investor was being amped up on the fear of missing out as prices kept climbing to new daily heights without taking profits. The main psychological mistake here was developing a strong attachment to these currencies which have “made me money” in the past and that by taking capital out of the market, we subconsciously “lack loyalty” to the blockchain community as a whole.
As of today, most altcoins including those with practical use cases, committed and talented development teams, and ample funding have dropped more than 90% from their all time highs despite having good fundamentals. This illustrates that ultimately, no matter how great a technology is, all markets operate on the same psychological principle of fear and greed exemplifying the saying “ the bigger the boom, the bigger the bust”. As a result of this market capitulation, many retail traders went back to their social media platform of choice looking for answers from “Cryptocurrency Experts” on which direction the market was headed next. This phenomenon was explained by Robert Cialdini a best selling author in psychology and behavioural economics. “Under such (uncertain) circumstances, people are especially likely to follow the lead of others”. As you can imagine, just because a person speaks with conviction and authority doesn’t mean they can predict a market. By failing to do ample independent research, one becomes susceptible to the biases of others and a proponent of the groupthink collective which often leads to poor investing decisions. We must be committed to learning and evaluating investments on our own behalf because individuals all have different risk tolerances and investing goals.
Investors can work past the stress and panic of these emotional swings by developing a trading methodology with risk management rules set in place. Even a volatile market such as this one can be contained between the risk parameters of “stop loss” and “take profit” limits. It is only human nature that once invested, we immediately have a bias for the asset to move in the direction of our profit targets. It is therefore imperative to analyse a trade prior to investing in order to enable clear thinking from an objective and unbiased headspace. Another point to consider is that occasionally the market will break from a trend and move in an erratic and unpredictable manner. In these instances, it is advisable reduce exposure to market risk by taking profits and a step back to develop a clearer picture of the emerging trend instead of making a hasty gamble on the next move.
As for the future of this market, just as we had a parabolic and irrational run up, we are now seeing parabolic selloffs and so my advice for investors would be to look for the same level of irrationality we saw at the peak of the bull market. Only when the majority is convinced that Bitcoin and the crypto space as a whole is going to zero will we begin the next bull run. A good investor looks to the future but a great investor looks to the past, so by analysing these prior mistakes, we can better prepare for the future. As a market matures, so do it’s participants. To remain competitive among other investors, we must combine a fundamental analysis on the cryptocurrencies we hold with a technical understanding of the market and strict risk management to stay ahead in this ever developing blockchain ecosystem.