The mainstream media has a tendency to only report news after the fact. When it comes to the market the media is usually late to the party. People who base their trades on media hype will always be one step behind the markets.
Buy High and Sell Low?
During the run up to $1200, the media was on fire with positive bitcoin news. Some speculators were even suggesting that prices could go as high as $1 million per coin.
The media love affair for bitcoin quickly turned sour after the price crashed. Once the markets hit a low of $166 talking heads were proclaiming the death of Bitcoin, adding to its long list of obituaries. As it turns out, that was the bottom for 2015.
In fact, later that year bitcoin gained 200% in value!
Sure enough, by the end of the year the same news outlets that were scorning Bitcoin changed their minds yet again, calling it the best investment of 2015.
If you chase price based on the media, you will buy high and sell low every time.
Smart vs Dumb Money
Smart and dumb money are two technical terms used in the investment world.
Smart money consists of contrarian traders who get skin in the game a couple of steps before the herd. They base their trades on technical and fundamental analysis to exploit price inefficiencies in the markets.
Dumb money refers to people who base their trading decisions on emotional whims. They like to chase the markets to buy tops for fear of missing out and panic sell bottoms.
In the Skill Incubator, our cryptocurrency mentoring students focus on learning how to spot smart and dumb money, which helps us with finding potential trade and investment opportunities.
I personally don’t fully subscribe to “efficient market hypothesis”, which states that you can’t beat the markets because everything is “priced in”.
There are more than enough traders and investors with direct experience who can disprove this theory. Now, I’m not going to completely discard this theory because it does have some relevance. The markets are efficient most of the time, especially when prices find equilibrium in a consolidation pattern.
That said, when the markets are driven by dumb emotional money prices are often exaggerated and become inefficient. Trading is a zero sum game and price discovery is a tug of war between buyers and sellers.
EMH states that it’s “impossible” to beat the markets but logic states that someone has to be the first to get in on the early trends. New trends are a race and the smart money are the investors who get priced in early. You would be hard pressed to argue that the price of bitcoin was efficient at $1200 and $166.
I know many professional traders who made a killing being contrarians during these severe market inefficiencies.
Perhaps EMH applies more accurately to a highly centralized stock market where large institutional investors can front run price discovery. In some ways EMH is correct in that retail investors can’t beat the institutions because the house always wins.
Cryptocurrencies are a free market and in the wild west dumb money drives price. This is why crypto is one of the easiest markets to trade.
The Phases of a Market
Dow Theory states that the markets are cyclical and that trends have different phases. Smart traders and investors who recognize this pattern can usually position themselves ahead of the herd.
Here’s a synopsis of these market phases:
The accumulation phase is the first stage of a new bull market. This happens after a long downtrend when market sentiment is at its lowest. I generally see a long period of consolidation within a tight price range during this phase.
This is the area where smart money quietly accumulates supply at cheap prices. Often prices will go sideways at bottom support because these investors are the ones holding the markets up. The idea is to accumulate as much as you can without pushing the price. This can be done by placing buy walls at various levels on the order book.
It’s often during this accumulation phase that the media will declare financial armageddon and encourage the masses to sell their investments at a loss. Perhaps the smart money controls the media narrative and uses it as a tool to acquire cheap investments?
Public Participation Phase
Eventually prices move past the accumulation range which attracts fresh liquidity as traders chase the breakout. This can often build momentum which sets the stage for the public participation phase. The markets turn bullish and the added volume leads to a series of breakouts producing higher lows and highs.
Smart investors may simply hold their position while smart traders seek to maximize their gains through buying dips and breakouts.
Once this phase reaches the end of its life cycle, the markets move into the excess phase. This is when prices get exaggerate by irrational excitement.
You know the party may be coming to an end when all the financial pundits become market cheerleaders. The most recent example of this can be seen in the ether markets. Notice how all the major news outlets are declaring ethereum as Bitcoin’s winning rival only after a 1500% gain in price. Where was the media when ether was trading at $1?
In the crypto world you know the end may be near when the moon chanting hits its peak. Pride comes before the fall.
This is the first phase of a new bear market where the early smart investors take profit and distribute their assets at a premium to late comers. Although prices start to make lower highs and lows, there is still an air of optimism in the markets as bag holders hold on to hope.
This phase is accompanied by a new cycle of public participants as people start selling off causing a bear trend. The final nail in the coffin is the panic phase where bag holders give up and dump their investments at a loss. These cheap investments are dumped into the hands of smart money looking to accumulate and the cycle starts again.