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Understanding Market Cycles

What’s so interesting about market cycles is that they might be considered a metaphor for our zebra-like life: there are white and black stripes, expansion is followed by contraction, and the extent and duration of the contraction phase is anticipated to be proportionate to the extent and duration of the preceding advance. 

Doesn’t it inspire a certain amount of optimism that even trading charts reflect this predictable logic of life? It turns out, every cloud does indeed have a silver lining. Let’s explore!

What behavioral economics has to do with market cycles

Behavioral economics studies how individuals and institutions make market decisions based on psychological, cognitive, emotional, cultural and social factors. And the idea of market cycles in behavioral economics is tightly bound to the shifts of fluctuating investor sentiment, or in other words, their emotional state.  

So, do market cycles change just like seasons, one after the other? Well, yes and no–you’ll recognize the pattern very soon. Take a look.

Retroactive effect

Remember when the going gets tough, after some time, it gets even tougher? And vice versa, when things go well in life and you enjoy the period of abundance, why that sudden stroke of luck? If you’ve been trading for quite some time now, you’ve already observed somewhat similar cycles in the market. It’s called the retroactive effect.

When the sentiment is positive, the prices are rising, the bullish trend is continuing, this is when the boosting attitude and confidence among the traders causes demand to increase and supply to decrease even more. 

On the contrary, when there’s an ongoing downtrend, the prices are falling, the bear market causes decline in prices, this is where a negative sentiment reduces demand and increases the available supply.

Over the short-term, the negativity in the market leads to even more negativity, and the other way round, positivity signifies more positivity.

Capitulation effect

Remember how the article started with the suggestion that market cycles change like seasons? Now that you know about the retroactive effect, you understand how this suggestion is not always true. At least, over the short-term.

And yet, there are of course situations when market cycles change–let’s take a look under what circumstances it happens. 

First of all, the cyclical or retroactive effect simply can’t last long. People get greedy and overhyped by the market momentum. In this emotional state, they can form a financial bubble, so as the price gets overextended, there comes the point of maximum financial risk, the local top, and then–boom! Panic, denial and anxiety starts to outweigh rational thinking. 

Now even those who were still hodling (holding on for dear life) no longer believe that the market will continue to rise, the wave of selling gets stronger, and that leads to the market capitulation effect–when holders give up and sell their assets close to the local bottom. 

So, is there a way to turn all the market cycles in your favour?

How to earn on retroactive effect and capitulation effect

As Warren Buffet says, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” 

Specifically, if you analyze the market cycles, see the retroactive or capitulation effect, they might be a very good entry point to either buy low or sell high. Even better, you can long and short on AAX Futures and earn as the price drops. 

Learn more on how to maximize return on crypto derivatives!

How to spot a good entry point

Of course, your intuition is a tool sometimes not sufficient enough to make decisions based on very technical details. That’s why many traders use TA, or technical analysis, to anticipate where the market is likely to go. 

There are dozens of technical indicators out there. Say, RSI, relative strength indicator index, suggests when an asset is overbought due to a strong positive market, and MACD, moving average convergence/divergence, that spots trend reversals.

We encourage you to explore TA even more, because it’s a precious tool in every trader’s arsenal! You can learn everything you need to know on our Trading Strategies section. 

Conclusion

Hopefully now you have a better understanding of market cycles that are closely entwined with human psychology, emotional states and an ability to rationalize when everybody is panicking. 

So, while trading, use technical analysis, but also don’t forget about the psychology of the market. 

Want to try some of these techniques? Check out futures markets for Bitcoin, Ethereum and a range of other cryptocurrencies on top of AAX!

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