When it comes to trading cryptocurrencies, traders need to consider other aspects on top of technical and fundamental analysis. Market sentiment is a key variable, which is why it is very important to understand the psychology behind price movements.
Those who are just starting to trade crypto should be aware that many times cryptocurrency prices rise or fall for no apparent reason. Sometimes this market is driven by emotions and it may lead to volatility spikes. Here are some basics mechanics that every trader needs to know when trading digital assets.
Crypto prices subject to speculation
Because broad cryptocurrency adoption has not yet been reached, these digital assets don’t have intrinsic value. That means their valuation is driven by excessive buying (during a bull run) and excessive selling (in a bear market). Basically, those who are active in the market are motivated to buy mainly because prices are rising.
Experts working for InvestOFund believe this is the fundamental reason leading to boom and bust situations. When looking at long-term price trends, it’s easily noticeable that there is a period of 1-2 years during which cryptocurrencies rise, only to be followed by a sharp reversal on the downside.
A speculative asset thus becomes risky and its price is hard to predict. This is common in a market that has yet to mature and does not benefit from large institutional flows, as opposed to other established markets such as stocks, indices, or commodities.
Common emotional reactions traders have
FOMO (Fear of Missing Out) is a common emotional reaction seen in the cryptocurrency market when prices are rising. As coins grow in valuation, those who are waiting on the sidelines are afraid to miss out on a bull trend. They enter and buy crypto, pushing the price to a higher level. Such conditions occur when there is growing optimism across the market and the majority of cryptocurrencies are experiencing gains.
On the flip side, FUD (Fear, Uncertainty and Doubt) is a negative market reaction witnessed when crypto prices are tumbling. Market participants who bought early on or entered the market during the late stage of the rally are now faced with falling valuations. Their profits evaporate, which is why a decision must be made fast.
When prices make a turn to the south, investors are challenged. That is why there is increasing interest in financial derivatives based on digital assets. Brokers like InvestOFund cover crypto, facilitating trading on the price moves, with no exposure to the underlying tokens.
Both FOMO and FUD act as self-reinforcing patterns, regardless of market structure (bullish or bearish). When prices rise, buyers waiting on the sidelines enter at higher and higher levels, not wanting to miss out on the rally. Eventually, the bull trend ends and fear takes over the market.
As prices go down, a cascade of selling emerges, further aggravating the move lower. Since emotions play an important role in where prices are headed, traders need to learn how to read the market mood and act accordingly.