Market sentiment has always played a role when in the price movement of assets. Assets refer to items of value owned by a person or entity such as stocks, commodities, real estate and now cryptocurrency. The terms bull and bear market are commonly used to refer to market conditions. Market sentiment is crowd psychology, as revealed by specific market behaviour and price action. Rising prices suggest bullish market sentiment while declining prices indicate bearish market sentiment.
This guide covers market sentiment in cryptocurrency and how you can use it to your advantage when investing.
What is market sentiment?
When referring to almost any asset market, you will hear it referred to by one of two terms: bull market or bear market. These are the two most common ways of characterising market sentiment. Sustained uptrends characterise bull markets, whereas bear markets are known for long-term downtrends. Historically, market sentiment has been observed to be a cyclical occurrence (Figure 1).
If you’re getting into asset purchasing at any level, you will want to understand what market you are buying into. Bull markets require a different mindset and buying attitude than bear markets. The most important part is understanding the market and tailoring your investing approach depending on the market sentiment.
Did You Know?
In Behavioural Finance, ‘herd mentality’ refers to investors’ tendency to follow and copy what other people are doing. Actions classed as ‘herd mentality’ are often triggered by emotion and instinct, rather than people conducting their own independent analysis. This is considered to be one of the reasons why the cryptocurrency market experiences higher levels of volatility.
How to measure market sentiment?
Measuring market sentiment can prove to be complicated. It is typically measured by observing the views and actions of the investor population.
There are many different ways you can capture cryptocurrency market sentiment. Several tools like LunarCrush assign a score out of several different cryptocurrencies based on their social sentiment. Alternatively, many investors use the cryptocurrency Fear and Greed Index to gauge market sentiment. This refers to a computer-generated score between 0 and 100 based on several indicators that help measure the levels of psychological stability (or instability) within the market.
What is a bull market?
A bull market refers to a period of time when the market is on the rise and economic conditions are generally quite favourable. During a bull market, investors typically have a lot of confidence that the uptrend in prices will continue over the long term.
One of the easiest ways to spot a bull market is a drastic upward trend in a given market. Some call it a “hockey stick” (Figure 2). This generally points to investors being “bullish” about the price rising from what it is currently.
When a bull market starts, the rise in price causes investors to become more confident in the assets within that market. This then furthers the confidence in other investors, creating a positive feedback loop that has a track record of bringing in further investment. This in turn results in an increase in asset prices.
Since the court of public opinion tends to steer cryptocurrency values, some bull investors will try to measure market sentiment.
What is a bear market?
The end of a bull market tends to mark the beginning of a bear market. When a market is bearish, it is in decline. It can also be described as a period when an asset’s supply exceeds its demand. In traditional stock markets, a market is typically referred to as bearish when it drops by 20% from its previous highs. However, given the more extreme volatility experienced by the crypto market, short and sharp downwards trends can often be misinterpreted as the end of a bull market.
History has shown that bullish sentiment for Bitcoin and cryptocurrency does not last forever, and investor confidence will begin to decline at some stage. This decline could be triggered by several things such as bad news, unfavourable legislation/regulation and unforeseen occurrences such as the COVID-19 pandemic. Since its creation, the price of Bitcoin and the overall crypto market capitalization have shown a tendency to follow a pattern or ‘market cycle.’ It is important to consider these cycles when investing in the crypto market.
Should I invest in a bear market?
Cryptocurrency investors and traders often buy during bear markets as the prices of assets are substantially lower. As such, this could then develop into a lucrative investment when the bull market eventually emerges.
The bottom of the market is very difficult to predict, however. Investors will often buy when they think the market cannot decline anymore, only for it to drop more the next day. A strategy to mitigate this risk is dollar-cost averaging (DCA). This involves investing smaller amounts of money at regular intervals (I.e. every week), regardless of market conditions. It is a powerful strategy that is proven to be effective in a number of public markets including cryptocurrency.
Did You Know?
In 2014-15, the price of bitcoin crashed nearly 80% leaving many investors hopeless in a recovery. By the end of 2017, the price had increased by over 9,000% which in turn created many headlines and catapulted Bitcoin into the mainstream.
Bull markets necessitate a different outlook and approach to buying than bear markets. A bull market is described as a phase in which more buyers are purchasing rather than selling. A sharp upward trend in a stock is one of the best ways to identify a bull market. The more optimistic investors are about a particular asset, the more likely it is to succeed. Market sentiment is an extremely important factor to consider when investing in crypto. Investing in both bull markets and bear markets have their upsides, but market sentiment should always be a consideration.