The belly of the bear
Views expressed in this article are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.
You’ve heard it throughout the bull - nothing goes up in a straight line. And though there’s been little in the way of relief since the year’s open, now that we find ourselves deep within Goblin Town proper, it’s important to keep in mind that the converse is also true. Throughout modern history, even in periods of deep recessions and macro drawdowns, bear market rallies have punctuated downtrends, oftentimes in the form of lengthy and convincing price rises despite overarching drawdowns.
Bear market rallies in recent decades (Goldman Sachs)
A play on psychology
Markets invariably bring out the best and the worst in us, with logic often muddied by emotion in the face of high volatility and evaporating portfolios. Operators - participants with the capital and liquidity to move the market - may ignite bear market rallies in the hopes that those desperately searching for a bottom are enticed into buying local highs, thus extracting further capital from retail once the downtrend continues.
Short covering
Another important dynamic in this context is the impact of derivatives. Simply put, shorting a position denotes an agreement to sell high using borrowed funds, and buy later at an (ideally) lower price point to round out the trade. This second leg is termed short covering, and often leads to temporary relief as shorts are closed out.
Since around $40k BTC, many have looked to Bitfinex traders’ sentiment for signs of reversal. In the chart below, we’ve overlaid Bitfinex longs against BTC’s price action - which tells an understandably perplexing story.
Long positions on the exchange have been soaring in volume throughout the drawdown from $46k, even as BTC continued its unabated decline. In hindsight, it’s likely that the bulk of this volume is in fact driven by short covering (closing out short positions in profit), rather than rampant optimism for immediate relief, as it would appear to be at first glance.
BTC:USD overlaid with Bitfinex longs
Takeaways
For all intents and purposes, the 4 year cycles of old have drawn to a close. With the entrance of institutions and deep correlations with equities, understanding the macro climate and market dynamics is more important than ever. FOMO is a dangerous motivator, and if left unchecked can tempt one to abandon strategies and projections to chase quick gains. The macro landscape remains as arduous as it has been throughout the year, with Jerome Powell reiterating this week that “nothing is off the table” in terms of curbing inflation, referring to the possibility of 100 basis point hikes.
It cannot be emphasized enough that patience and capital preservation are the key to surviving - and thriving - in such challenging conditions. In other words: employing a healthy dose of skepticism goes a long way in tempering the ever-present urge to FOMO. Diving into the dynamics of price action and their interplay is a worthwhile endeavour for any market participant; the more you understand, the easier it becomes to cut through the noise and stay true to planned strategies.
