Understand the psychology of market cycles

2022-11-18, 07:33

TL;DR

- The psychology of market cycles refers to the vital forces in crypto trading that drive the decision of large numbers of traders.

- Adherents of behavioral economics presume that all price movements, regardless of market, are influenced by traders' psychology, making emotions the primary motivator.

- The critical emotions during the bull market when there is active buying include euphoria, optimism, greed, and trust.

- During bear markets, when the cyclical nature of trading leads to a downtrend, anxiety, denial, panic, and fear are experienced.

Introduction

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People have used money for trading since the invention of the first coins in ancient Lydia, all the way up to modern cryptocurrencies. The fundamental market laws of demand and supply still apply since the first transaction. However, we now better understand the psychological foundations of various human actions. They are strong forces in crypto trading, driving your choices and the choices of large numbers of other traders.

Psychology of market cycles explained.

Together with project fundamentals, social platforms and other internet forums considerably influence crypto project performance. Human capital factors such as the team structure of a project or company and marketing and public relations activities can all play a vital role. However, underlying all of these considerations is the user's or investor's psychology. The psychological state of a trader or an investor gets to decide how information is processed, what is prioritized, and what has the maximum impact on their behavior.
We must answer the questions on who the investors and traders are, what draws them to a crypto project, and what emotion drives their decision-making to understand the complex psychological factors at work better.

Emotions and market cycles

Adherents of behavioral economics presume that all price movements, regardless of the market, are influenced by traders' psychology. As a result, emotions become the primary motivator. Personal feelings and expectations combine to form market sentiment, an average of all emotions at any given time.

When most participants expect interest rates to rise, the sentiment is positive. This phase is referred to as a bull market or an uptrend in trading. When the market expects the target asset to fall, a negative pattern forms, and we enter a bear phase or downtrend. These moves are linked because they follow each other.

Let's look at some examples to understand emotions better.

Bull Market
This market phase is characterized by active buying. Investors expect prices to rise indefinitely, so they buy more assets. The key emotions include euphoria, optimism, greed, and trust.
Retroactive effects frequently fuel bulls. Assume that traders' market sentiment improves as prices rise. Prices rise due to this bullish pattern and rise even more as bulls gain power. When demand is overstimulated, an overly strong uptrend may form a bubble. Traders develop irrational greed. As a result, a local price high is created, which is the riskier position.

Instead of an immediate downtrend, markets may experience periods of horizontal movement following the local high. These are referred to as distribution stages.

The Bear Market
In any case, the cyclical nature of trading leads to downtrends. As rates begin to fall, people experience emotions similar to the Kubler-Ross stages of grief. Initially, traders deny that a bear market has formed, so they hold assets. Frustration, bargaining, and anxiety may appear later. Finally, market sentiment turns negative as the majority accepts new conditions and sells funds. It is referred to as market capitulation.

Unfortunately, many traders refuse to sell at the best time and instead dispose of their coins near local lows. The market then stabilizes and gathers strength for the next uptrend. Additionally, accumulation stages with horizontal moves may occur before rises.

During bear markets, the following emotions such as anxiety, denial, panic, and fear are experienced:

The role of FA and TA in understanding the psychology of market cycles

It may be easier to understand markets if we accept that they are influenced by global psychology. First, fundamental analysis (FA) is indispensable for all traders. Remember the golden rule: buy when everyone else is scared and sell when everyone else is greedy. To place the best deals, try to understand current market sentiment. It would help if you tried to catch local highs and lows.

Second, technical analysis (TA) can be beneficial. You can learn about psychological patterns by studying previous market cycles. The BTC/USD pair in 2017 is the most famous example. Due to highly positive sentiment, Bitcoin skyrocketed from $900 in January to $20,000 in December. But then it went downhill.

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Characteristics of crypto traders

What personality traits and psychological characteristics best describe crypto traders and influence the understanding of the psychology of market cycles?

In a recent survey of 1000 investors conducted by the UK's Financial Conduct Authority, 76% reported feeling competitive when investing, while 68% compared it to gambling. It is consistent with research on the psychological characteristics and phenomena that influence crypto investment decisions.

Social interactions

Crypto investors and traders are extroverted, social, and outgoing people. They typically score low on cooperativeness when tested on various personality traits, which may help explain competitive behaviors.

Openness to new experiences

Overall, cryptocurrency investors and traders are more open to new experiences and seek novelty. This trait enables them to actively seek out new information and improve their skills in the crypto world. On the other hand, a constant novelty-seeking attitude brings higher levels of mood instability and impulsivity.

Fear of missing out (FOMO)

FOMO is defined as a desire to stay connected with what others are doing. It is more of a psychological phenomenon than a characteristic. FOMO is common among cryptocurrency investors and influences their decisions.

As investors join crypto communities online, they have constant access to project discussions on Twitter, Reddit, and other platforms. It creates social pressure on investors concerned about missing out on buying and selling prospects and losing control over their investments. FOMO is exacerbated by the cryptocurrency market's high volatility and 24-hour availability of trading platforms.

Ten stages of the Market Cycle Psychology model

Stage 1: Hope.

"Hope is the first indication of market recovery after a period of "Serious Disbelief." At this point, the market shows signs of a possible bull run.

Stage 2: Optimism.

"Optimism" is the second stage. As new money is constantly invested, prices begin to rise significantly. The "Optimism" stage is reached after the market has been upward for several months.

Stage 3: Belief.

Over time, optimism transforms into genuine "Belief." During the "Belief" stage, the first signs of a bull market appear. Investors continue to put money into the market, and new investors are entering.

Stage 4: Excitement

Keeping track of your excitement level during the "Thrill" stage is critical. At this stage, the market is trending upward; people begin to invest in random projects, believing that the market will continue to trend upward.

Stage 5: Euphoria.

Strong crypto market output at this stage leads to a widespread belief that growth will continue unabated and that prices cannot fall. Methodical sell strategies are abandoned, and negative news about companies or crypto coins is brushed aside. Cryptocurrency investors are willing to pay any price for it. This stage's key features are extreme optimism, a surge in ICOs, and excessive valuation.

Stage 6: Complacency

The bull run is beginning to stall at this point, and the first signs of a market reversal are appearing. People commonly believe that the complacency stage is just a brief respite before the bull run resumes.

Stage 7: Anxiety

The possibility of making money is the last thing on an investor's mind at the seventh stage of the market cycle. The market is the last thing on an investor's mind. Instead, investors attempt to figure out how to get their money out of the market before it is too late.

Stage 8: Denial

During the Denial stage, investors act defensively, and many choose not to sell, hoping for a significant upward correction. Investors believe the market will continue to fall.

Stage 9: Panic

The bear market becomes the investor's new reality during the "Panic" phase. Traders will try desperately to sell investments to recoup some losses because they are afraid they will lose everything. Typically, it is here that a significant sell-off occurs.

Stage 10: Depression

People lose all faith in the market during the "Depression" stage. The market cycle reaches its lowest point at this point. Stabilization occurs at this point, and the market can begin to build again. The depression stage, however, can last for a long time (also known as a "crypto winter"). After this phase, the hope stage can resume.

The Importance of Understanding Crypto Market Psychology

Conventional methods of forecasting market behavior cannot meet the enormous challenge of comprehending the turbulent crypto market.

The lack of a centralized system complicates the task of gauging and understanding behaviors. Instead, crypto technology is based on a variety of user-based models.

According to behavioral finance and financial psychology research, investors base their choices on certain psychological traits (e.g., cognitive bias, herd psychology). This results in market anomalies and ineffective trends.

Hence, it is critical to consider all obtainable user-oriented information to understand the structure and patterns of the crypto market.

Conclusion

The crypto and financial markets, like sentient life forms, have cycles. However, emotions often get in the way of understanding the psychology of a market cycle. We frequently buy or sell at the wrong times, exuberantly buying at market highs and panic selling at market lows. The opposite is true for successful investors.

Author: Gate.io Observer: M. Olatunji
* This article represents only the views of the observers and does not constitute any investment suggestions.
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