Investing Rule of Thumbs for Bitcoin

What are the different players in the game of Bitcoin, and how can we outcompete them?

I remember during Bitcoin’s previous all-time high (ATH) at $64K, I was conversing with my fellow trader on why there is so much bullish news like different countries’ federal reserve buying Bitcoin. Yet, the price is moving sideways with some drops downwards. Now, reflecting, it was one of the first signs that we were at a local peak.

The good news is already priced in, so much so that additional good news couldn’t affect the demand any further and the price of bitcoin any higher. This positive sentiment is not reflected in the price movement, so it was a sign that we are running out of hype.

Greed was also exceptionally high. Scams, shi*tcoins, and pump and dumps were rampant. Everyone was talking about Bitcoin, even people who have never cared about space before. The market was highly leveraged because people thought the price could only go up. And then the crash happens.

When you push things as far as they can go, and it cannot go any farther, it will retrace and fall back. That is what happened at the peak. It was first triggered by Elon Musk’s tweet about the sustainability of Bitcoin and how it is not energy-efficient and environmentally friendly. This caused the following domino effect that is, in turn, the crash.

The hype bubble needs a simple prick of a needle of any bad news and blows off all overly priced-in good news. Market makers add to this because they have always taken the other side of the trades for retail and institutional investors. This was their opportunity to make back the money they have been paying off to retail investors, so they wipe the market clear of leverage with one fell swoop of a flash crash. The market makers are your exchanges, like Kraken and Binance. If this were a poker game, they would be the house. And when you put your shirts on the table to bet that you will win, you will lose everything. And people did.

Then we entered a bearish sentiment (I am avoiding the term bear market here because you need to be trading down and sideways for longer than few months). During the latest local bottom of $29K of Bitcoin’s price, I start to hear such bearish news, like how the government is hunting down on crypto with banning and regulations, yet the price doesn’t budge down further. This is the same, yet opposite, of what happened during the tail end of the bull run. We have exhausted the bearish sentiment from the crowd. The price pushes up to $48K, again wiping out the over-leveraged bears who have been shorting Bitcoin on leverage. A short squeeze happens, facilitated by the market makers, who take long trades behind the shorts. The question now is whether the short squeeze pushes the sentiment high enough to get back into the bull run.

Let’s look at the stakeholders in the market:

News

Traders rely on the news heavily. If you walk into any sales and trading desks on an investment bank, you will see screens for news and different charts for traders. The news plays an important role. That is why companies like Bloomberg are making billions of dollars every year. But although they are in the game, and traders depend on them, they are not always acting in the players’ interests. What is the main source of revenue of the news? That people continue to read from them. And from their POV, they need to share news on what people care about.

But since people have biases, the news plays on that and feeds further into their biases to attract more engagement. So, in the case of Bitcoin traders, when the market is bullish, people care more about bullish news and ignore the negative ones. And vice versa, for the bear market, people hyper-focus on negative news that confirms their biases.

The news play into these mindsets. This phenomenon is called cognitive ease (the opposite is cognitive dissonance), where people seek information that confirms what they want to hear. In return, this act gives them dopamine (a joy hormone). So, the hard part here is for traders to follow their instinct and facts but not form confirmation biases. That is some hard mind game there.

My general rule of thumb is to do the opposite of what the news suggests. Bad news, buy! Good news, sell! Essentially, this further feeds into the statement ‘buy on rumours, sell on facts.’

House/ Exchange

We then have the house or the casino of all poker players, i.e. exchange. They facilitate trades. They host the data. They also have market makers that make sure everyone’s trades go through — lots of power on their hands. For short-term traders, you are competing with these guys for a winning hand. The odds are stacked against you since they have more information and access. When you make a buy/ long, someone else needs to be on the other side selling it to you, and they are called market makers (part of the exchange).

So what happens when everyone is buying on high leverage, the exchange gives you that leverage, meaning if you win, they have to pay you back more. Now that wouldn’t be profitable. So, by allowing leverage, they lure the overly greedy in either a bull or bear trap with extensive with a flash crash or a short squeeze, hence wiping them out with everything on their hands. So leverage is great, but that is a sweet candy that the house used to take all you have essentially. Can you say that using the house’s leverage, you will take money away from them with these trades? Can you be right 100%? Can you know when flash crashes and short squeezes happen exactly?

Retail Traders/ Shrimps

This is you and me, the shrimps of the oceans. This group means any traders and investors with a pocket from $0 to a few million. Together, we make up a big portion of the market and can move markets (look at GameStop and AMC). We are more rational and are driven by and are also the creator of market sentiments.

Although we are large, we all have small pockets to feed ourselves and our families. Because we are not rational, we start bubbles all the time and also get sucked into them. Some of us lose in pumps and dumps and over-excitement in new assets without fundamentals like Safemoon. Some of us are overly greedy and impatient and want to get rich quickly by using an absurd amount of leverage on a big size bet of our entire portfolio. Some of us are just pure gamblers.

So I personally wouldn’t trust this group and be careful with the sentiment they are pushing. Because the market is so easily accessible now (free trades on WealthSimple and RobinHood) and we can easily access each other through social media (TikTok, Twitter and Reddit), retail investors have a great share of the market and great pull as well. But that is not necessarily a good thing.

Institutional Investors/ Whales

The rich people. This group should have above a few hundred million in their pocket. BlackRock and Fidelity are some of the largest whales, with $3 trillion in assets under management. They are cool, calm, and collected. Somehow, they are always able to catch the price near the peak or the bottom. They don’t trade. They make longer-term investments. They move markets secretly. They trick and manipulate the shrimps to make more money. So maybe it’s best to follow the whales? I would.

All in all, there are many players in this game. They are quite predictable once you know their incentives and their personalities. It is up to you to connect the dots in each event and make a calculated bet, with stop losses (insurance on you being wrong). It would be best if you were disciplined to stick to your strategy, calm to understand the information collected to process market sentiments, patient with conviction to see your trades go your way, and never greedy to use leverage.

Rule of thumb:

  • Buy on the rumour, sell on fact.
  • Have stop losses ALWAYS.
  • When good news doesn’t move prices up, sell. When bad news doesn’t move prices down, buy.
  • Don’t be greedy and take on leverage.
  • Have long-term trades. If not, the market makers will eat you up. Fundamentals

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I believe innovation is the key to growth | DarkByte Research | Data Science, Blockchain, Fintech | UWaterloo