Psychology of the Market Cycle
Regardless of the type of trading used in different markets for stocks, crypto, equity, or other types of assets, traders and investors have a lot of metrics to take into consideration when handling their portfolios. One factor that needs to be taken into consideration is the psychology of the market. Market psychology is described as the influence of emotions—or reflection of emotions—concerning market movements and price fluctuations. What exactly is the psychology of the market cycle, and why does it matter?
What is Market Psychology?
The psychology of the market cycle relies on the presumption that market movements can be influenced and affected by the participants’ emotions. Market psychology also involves the idea that the market movements reflect participants’ emotions.
Many economists, traders, investors, and financial experts believe that the market is driven by emotions and sentiments, creating fluctuations and market changes, which is why the psychology of the market cycle is important in trading. The sentiment is the overall feeling that market participants have in relation to the price action of a certain asset. If the overall sentiment in the market is positive, the prices rise, and the market is considered bullish. When the market is bearish, the prices drop, and the sentiment in the market is negative.
The market is dynamic, which means that the prices of assets are constantly changing and fluctuating to reflect different overall sentiments—not all traders have the same feeling about a certain asset or a market of assets. A positive market sentiment normally causes demand to increase, and the supply consequently decreases, causing the prices to rise. If the market sentiment is negative, the demand declines, and the overall availability of existing supply increases. As a result, a negative market sentiment forms a downtrend and causes prices to drop.
Following fluctuations in sentiment in the market, market cycles change to form a dynamic environment.
Market Cycles and Sentiment: Emotions Form Market Cycles
All markets, regardless of the type of assets, go through market cycles—that is, changing market trends. These trends can be either positive or negative, and the market may expand or contract based on the trends, creating market cycles.
Optimism and greed may be the driving force behind uptrend market cycles, in which asset prices go up with declining supply and inflating demand. Positive sentiments inflate prices and may drive the market even higher while forming strong buying activity. At times, prolonged positive sentiments may cause a bubble in the market, and that bubble may burst because traders overbuy. This situation may lead to a major selloff and negative sentiments, forming the next market cycle and leading to downtrends and price drops.
After the highest point is reached driven by positive sentiments, overhyping, greed, and hopes for major financial gains, the price starts to erode. Consequently, negative sentiments appear, which may lead to panic and anxiety among traders, driving the price further down from that point. This case would lead to capitulation.
Capitulation emerges when the selling pressure reaches its peak and traders sell their assets at lowes. Once a local low is reached, the selling pressure stops, and the market cycle switches once again, usually entering sideways trends before hope for financial gains emerges in the form of hype and high expectations, and positive market sentiments returns.
Bitcoin and Psychology of the Market Cycle
While the psychology of the market cycle and changing sentiments were initially noted in the stock market, other markets, such as cryptocurrency, are also driven by sentiment. We can take Bitcoin as an example of a top-trading digital asset that follows market cycles, just like stocks. Altcoins, on the other hand, follow Bitcoin’s movement in the market.
As a rule, whenever BTC starts to gain positive sentiments, other cryptos follow—that’s the psychology of the market cycle in a nutshell. Take 2017 as an example of how market psychology can drive asset prices up and down. From January to December 2017, Bitcoin’s price jumped from nine hundred dollars to twenty thousand dollars per BTC unit, driven by positive sentiments after BTC reached over one thousand dollars per BTC. The price kept rising with minor daily and weekly fluctuations, and new investors joined the hype. Expectations for major gains, a bit of greed, and a lot of hype pushed BTC to the price of twenty thousand dollars in less than twelve months from the initial value of nine hundred dollars. However, the price started to drop once it reached its peak value. Many traders started to sell their assets to acquire gains, so the price started to drop and brought a negative sentiment.
Beyond the hype that first inflated the price of BTC and then pushed it down to new lows in 2018, BTC has been stabilising its value in 2019 and 2020, trading as a valuable asset with constant technical improvements from the community of dedicated developers. The supply of BTC is limited to twenty-one million, which is why it is likely that the value of BTC will continue to gradually rise with the declining availability of BTC supply. However, the price will continue to fluctuate based on market psychology and traders’ sentiments.