Understanding market cycles: Why they’re important, and what they mean
by Justin Wright, YIELD App co-founder
In both traditional and crypto markets, analysts and amateurs alike love to talk about market cycles. In fact, as anyone that’s paid a subscription for a Bloomberg Terminal will know, it’s big business. Countless hours and dollars are spent on trying to analyze, understand and predict market cycles, with the aim to get in and out at just the right time to make the most money.
Fundamentally, a market cycle is simply the space of time between a peak — or high — and a trough, or crash. As everyone knows, buying low and selling high is the best way to play any market, and so understanding previous cycles can, in theory, help us to predict what might happen in the next cycle and how we should invest at each stage.
Traditional market cycles
Traditional markets tend to have long market cycles that consist of rising periods, or “bull” markets, and falling periods, or “bear” markets. Looking at the US market between 1930 and 2017, the average bull market cycle lasted for around 9 years while the average bear market cycle lasted around 1.3 years.
In traditional markets, a number of factors will affect a market cycle, with political stability and economic and industrial development being key pillars of a bull market, while instability and declining economic activity are factors of bear markets. In addition to this will be the “unknown unknowns” — unexpected events like a flash market crash, a war or banking crisis.
Despite the varying lengths and contributing factors of each cycle though, as you can see above, each follows a fairly predictable shape and pattern. This pattern is accompanied by investor behaviors and emotions that were famously broken down by Karen Bennett at cheatsheet.com, into 13 key stages: disbelief, hope, optimism, belief, thrill, euphoria, complacency, anxiety, denial, panic, capitulation, anger and back to disbelief.
As one might guess from looking at this chart, the aim — on the buy low sell high model — is to buy into an asset or asset(s) at the “disbelief” stage and to sell at the “euphoria” stage, watching the market crash as you sip a martini on a yacht waiting for the disbelief stage to buy back in. The reality, however, is quite different.
In practice, the euphoria stage is where most people tend to buy-in. This is when the media will be singing the praises of the hottest stocks and assets out there, profiling young millionaires and prompting thousands if not millions of (typically) inexperienced investors into the market.
Because humans are naturally averse to loss, as the market falls these investors will usually hang on right until their nerves break at the panic stage, selling into a falling market and losing all of their gains, and likely a good chunk of their initial capital. They will then sit, nursing their losses until the euphoria stage again, and on we go.
Cryptocurrency differs from traditional markets in a few key areas, the most significant being the length of its market cycles, and levels of volatility, which are strongly linked. Looking at Bitcoin, the most established cryptocurrency, market cycles have tended to last around 4 years since the coin started actively trading around 2012.
In addition, the volatility of Bitcoin is legendary. In traditional markets, a 5% daily decline is a harbinger of doom, a 10% decline a technical “correction” and anything more than a 20% fall is an all-out crash. For Bitcoin and cryptocurrency at large, swings of 20% either way are often all in a day’s work.
However, where cryptocurrency and traditional markets almost totally align, is the shape and behavioral pattern of a market cycle. As anyone that was around in late 2017 will remember, it was when Bitcoin started climbing on a parabolic rally that the media began to pay attention, and it was at this point that great waves of money flowed in from inexperienced investors.
What also happened around the time that Bitcoin was firmly in the euphoric stage, however, was the beginning of a big rally in altcoins as new investors keen to capture the massive gains of early Bitcoin adopters poured into lower value coins. XRP (the token of Ripple) was one of the main beneficiaries of this in 2017, surging 1,260% in December, while a huge wave of ICOs, or initial coin offerings captured bags of new money.
The result of this particular market cycle is well known: by December 2018 Bitcoin had fallen from a high of $20,000 a year earlier to less than $7,000 while many altcoins were wiped out and ICOs banned (XRP is arguably its own story, one which has led to legal actions from the SEC). These headlines aside, a trend was firmly established: as Bitcoin overheats and starts to wane, altcoins come into season.
This was evident through the tumultuous market of 2020. Following the global market crash that saw Bitcoin tumble to a little over $5,000 in March, the coin made an astounding recovery to reach more than $10,000 by late July, where it leveled and stabilized. This was the altcoin market’s time to shine, and when DeFi began to take shape and grow from a market of a few hundred million to the $37 billion marketplace we see today.
The cycle to come
Since then, of course, Bitcoin has taken off again and is trading around $50,000 per coin. Meanwhile, altcoins are not faring too badly either (although we are not yet in an altcoin season, which is when 75% of the top 50 coins perform better than Bitcoin over the previous 90 days). Indeed, things are starting to look a little frothy.
Nonetheless, exactly where the crypto market sits in the current cycle is debatable. Some see the current rally continuing until 2022 before a sharp correction back to current levels, while others — particularly those that remember 2017 and the three years it took for Bitcoin to recover — see something a little sharper and faster.
In a market that is less than ten years old and much, much younger if you take Bitcoin out of the equation, it is extremely difficult to make even an educated guess of the way this current cycle will play out. With so much institutional money and interest now invested in the cryptosphere, though, few see a correction like 2018 on the horizon.
Moreover, the boom in altcoins has not been driven by meaningless ICOs of meme coins (although there has been a bit of that, admittedly), but rather by the establishment of an alternative financial system that is bringing yields and wealth creation back to people locked out of these amenities for more than a decade. This may drive an entirely new market cycle altogether.
About the Author
Justin is YIELD App’s co-founder. He has over 20 years of experience in investment banking, fund management, consulting and FinTechs. He specializes in financial product development, multi asset class arbitrage, and delivery of technology through strategic partnerships. Justin is a passionate advocate for FinTech regulation and increasing financial literacy across the globe. He has also made regular appearances on CNBC Asia’s business programs.