Wall Street Cheat Sheet: Understanding Market Cycles

A couple of years ago, in 2017, the crypto markets had an epic bull run. Between January and December 2017, we saw a 20x increase in the price of Bitcoin, and then the market crashed. Then people shared a Wall Street Cheat Sheet. This type of massive boom and bust scenario, while not typical in the short term, has happened many times in the history of organized capital markets. So many times, in fact, that the generic event has become a meme that is the subject of this piece: the so-called “Wall Street Cheat Sheet” (or alternatively “Market Cycle Cheat Sheet”).

Here, we will discuss the Wall Street cheat sheet and what we believe it is trying to express, and what you as a trader or investor in crypto, or anything else, can take away from it.

A market is a market

It seems clear that crypto has become, for some, an entry point into the broader, more general world of trading investing. And while all markets have their respective differences and idiosyncrasies, they also have some things in common. One of the uniting forces common to all markets is emotion: whether it’s the S&P, mortgage-backed securities, or Bitcoin, the two emotions of caution and anticipation (more commonly referred to as “fear and greed”) are assumed. and the emotional spectrum that lies between these two poles, dominate the flows of any market. Perhaps no other image captures the emotional component of trading investing as succinctly as this Wall Street Cheat Sheet, which any intermediate-level market watcher has likely seen. The Bitcoin market alone has seen at least three major market cycles that could be grafted onto this general template, shown below. The Wall Street Cheat Sheet shows the market cycle of a hypothetical asset bubble bursting, after a supposed “parabolic” price rise. . It is a generic pattern, not taken from any actual chart (of which this staff writer is aware), and therefore any asset bubble can fit within the pattern. That this is not a real chart, but rather a notional one, is fine because what is important is not the specific market structures or patterns on the chart, but the generalizations about the collective and typical emotional reaction of a market to this type of price action. If we distill the Wall Street Cheat Sheet to its basic message, what it aims to show are the emotions that drive huge and volatile moves in the markets, the aforementioned fear and greed. To be more specific, the emotions represented in the Wall Street cheat sheet are those of “dumb money,” the mostly unprofitable participants in this particular market pattern. After all, we can presume that both successful and unsuccessful traders/investors experience fear and greed at some level. Critically, they do not occur at the same time; And winning traders should not be overcome by emotions either. Losing traders/investors, whose emotions are shown here, are always at least one step behind the market trend. Their emotions always trigger too late. Put another way, they are having the right emotions at the wrong times: they are afraid when they should be greedy, and greedy when they should be scared. Overwhelmed by what they perceive as an ironic trend, these people/entities are attempting to enter the market that they falsely perceive as virtually risk-free.

Market trends are complex

In principle, they are doing the right thing. The saying goes that “the trend is your friend,” and it is completely accurate. The basis of all trading and, to some extent, investing is defining trends. Discovering trends on a variety of different time frames and being able to jump on them for the ride is what trading is all about. The rest are just details.

However, this saying is packaged with a second, often unmentioned subjunctive clause: “the trend is your friend, until it isn’t.” Trends are complicated and multi-dimensional, and are actually not that easy to analyze accurately across all time frames. After all, if it were easy, everyone would do it. And here, on the Market Cycle cheat sheet, you can see a classic concept: an incredibly strong trend that seems like it will never end. All trends, all of them, we assume, end, but before they do, they often fake, reverse, zig-zag, go against technical indicators, zig-zag again, and defy expectations. There is an entire mature and fully developed methodology called Elliot Wave Theory dedicated to investigating where the trends are in a market and defining its structures in minute detail; and although its principles are simple enough, it is quite difficult to learn and requires a trained hand to apply. All of this is to say that, for a novice, it can be difficult to say precisely what the trend is on time frame X; More to the point here, it’s very difficult to tell when a trend is ending. Recent examples include the seemingly endless S&P500 bull run, the Tesla bull run, among others. In fact, Market Cycle’s cheat sheet could easily be grafted onto Tesla’s chart. In fact, this difficulty in detecting trend extremes is the essence of the premonition trading maxim “don’t try to catch a falling knife,” the statement of which naturally applies to both longs and shorts. The falling knife is an ending trend, and trying to time the conclusion of the trend is, as the saying goes, extremely risky. Therefore, entering a trend that seems very established and certain to continue can be as complicated as betting against a trend that looks as if it will end very soon Any emerging bubble that Wall Street’s cheat sheet can be grafted onto will include many traders who lost big bets on a trend reversal (again, like the Tesla cutters recently), and the traders who entered believe the trend was safe. Here we can return to our losing traders, first considered above, who were “doing the right thing.” What they were doing well was following the trend, jumping to a clear direction in price movement. This is reflected in Wall Street’s cheat sheet right in the disbelief phase (“Time to invest”), and then in the excitement phase (“I must tell everyone to buy!”).

The right move at the wrong time

These traders/investors are too late for the trend, and presumably do not protect themselves against the danger of reversal in what is likely the end of a trend. They are buying the trend after the trend has become very obvious to everyone; They are doing the right thing at the wrong time. They should have bought the trend earlier, when it was first detectable, which requires significant skill, but not as soon as it is just a matter of betting or catching the falling knife. The result is what we see on the opposite side of the asset collapse. : complacency, anxiety, denial and panic. These people are confident that they are still invested in what is ultimately an uptrend. Because of greed, they don’t see that the trend has probably ended and is reversing, which makes the complacency part of the chart perhaps more compelling. We can see a real-life example of this area on the 2018 Bitcoin chart, below.Source: TradingView
Here, we can see in early January that the incredible uptrend had probably ended, and a reversal had begun. This was a last chance for any decent trader to sell (the best traders had probably been gradually exiting positions throughout December), but many held on for a while believing it was just a speed bump before the next monster run. Ultimately, the key lesson of the Market Cycle Cheat Sheet is the trend lesson. Knowing what the trend of a given asset is is, in a sense, the only thing that matters in trading. As in chess, what begins as a simple game becomes almost impossible to answer definitively. Unless you actually monitor a market, which would be fraudulent, it is impossible to say with certainty when a trend is starting or ending. You can never know beyond any doubt; It’s always a risk, and the best response is to make the most educated and informed assumption possible while strictly managing the risk. When education and experience replace emotion, you can get a trend, more often than not. Featured image via Pixabay.

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