Serious about trading crypto, let’s talk about Market Efficiency, Headlines Trading and Counter-Trading Markets’ emotions.
Crypto Trading is risky, daunting and very profitable but before deploying your hard-earned capital let’s discuss the key concepts of Market Efficiency, Expected Value, News/Event Trading as components of your Trading edge. In this discussion, we will delve into the Efficient-market hypothesis, its foundational principles, the limitations of its accuracy, and the advantageous edge that can be derived from it, plus headlines trading and counter-trading.
First, the Efficient-market hypothesis -EMH- posits that asset prices consistently reflect all available information. However, this assertion is only partially accurate especially in crypto markets. In reality, at any given time, asset prices mirror the perception that current market participants hold regarding the information they have received.
The key distinction lies in the fact that information is interpretive and disseminates over time. It cannot be precisely priced at the moment of its release. This introduces two critical variables for news traders: the interpretation of the headline and the speed of headline spread, how fast does a positive or negative announcement, or rumor spread through conversation channels such twitter, discord, telegram…
Consequently, it is advisable to perceive the market as a slow, partially efficient, and emotionally driven entity. This perspective yields two direct consequences and edges to exploit: the ability to enter before others due to the market’s slowness and the opportunity to fade parabolic euphoria in an emotional market.
Furthermore, one must keep in mind that the Efficient Market Hypothesis in crypto markets is a subject of debate as these digital assets exhibit characteristics that challenge the assumptions of the EMH. Here are some points to consider:
- Information Asymmetry: In traditional financial markets, there are regulations and institutions that aim to ensure transparency and reduce information asymmetry. In contrast, the crypto market is relatively young and less regulated, leading to greater information asymmetry. This can create opportunities for traders and investors to gain insights that are not immediately reflected in prices.
- Market Immaturity: The crypto market is still evolving and can be considered less efficient compared to well-established traditional markets. The lack of widespread adoption, regulatory clarity, and the presence of market manipulations can contribute to inefficiencies in price discovery.
- Volatility: Cryptocurrencies are known for their price volatility. Rapid and significant price movements may occur in response to news, social media trends, or other factors. This volatility can be seen as a sign that the market is not fully efficient, as prices may take time to adjust to new information.
- Liquidity Issues: Some cryptocurrencies, especially smaller altcoins, may have lower liquidity, making it challenging to execute trades without impacting prices. Illiquidity can contribute to inefficiencies in price movements.
- Behavioral Factors: Emotional and speculative behavior often plays a significant role in crypto markets. Traders and investors might react emotionally to news, causing prices to deviate from fundamental values. Behavioral biases can introduce inefficiencies in market pricing.
While there are arguments against the full applicability of the Efficient Market Hypothesis to crypto markets the same statement could be made regarding conventional financial markets where markets are similarly dynamic, and conditions do change over time. In mature segments of crypto market participants may still adhere to aspects of the EMH.
Headlines Interpretation
One of the simplest edges you can develop involves correctly interpreting headlines swiftly, understanding how people will interpret them, and estimating how quickly the information will spread. While seemingly straightforward, this requires practice through monitoring headlines and market reactions.
Interpreting headlines promptly and understanding how they will be perceived are contingent on the current market state. The impact of any news title is influenced by how previous ones reacted to price, necessitating constant adaptation to extract value.
Estimating how quickly a headline will spread depends on factors such as the content of the headline, where it was posted, and the likelihood of other outlets reporting on it.
When a headline is released, market participants begin pricing in the new Expected Value (EV) for the asset. Your task is to more accurately calculate this EV and take a position earlier than most other participants.
For instance, when Binance has announced the burning of $LUNC trading fees, it represented new unexpected information not yet displayed in price, then it reached a massive audience (including traders and non-traders) which materialized as a net positive for its market price. Your role is to estimate how much the asset should appreciate and strategically enter the market, your task is forecasting the magnitude of price shift given the new information broadcasted.
Determining whether it is still viable to enter involves internal calculations based on your EV estimate and how much the asset has already appreciated. Importantly, this trading style allows you to exit without needing an exact bullish estimate; instead, you gauge how quickly participants have received and priced in the news.
Counter-Trading the Market’s Emotions & Convictions.
A second advantageous edge stems from the market’s emotional nature, allowing for profitable shorting opportunities at the peak of parabolic FOMO-driven moves. For instance, consider $ADA’s parabolic surge based on smart contract hype, followed by the release of smart contracts, leading to a lack of future catalysts. At its peak, 3.10$, ADA’s market cap reached 108 billion which is inherently a non-sense, this market valuation is superior to the market capitalization of both Honda & General Motors, at this point in time, Cardano had zero working products, zero platform, while Honda & General Motors have been producing cars decades before the computer: its price crash was obvious at the 3.10$ price level.
Similarly, $LUNC experienced a parabolic move based on burn hype, but the absence of support for burning trading fees presented an ideal shorting opportunity, in fact, the Anchor protocol offered a generous and unbeatable high yield of 19.5% to UST depositors, which generated significant inflows of deposits and led to a large increase in UST issuance. Any diligent crypto trader/investor who would have taken the time to research, to understand the Anchor Protocol would naturally realize that the deposit and lending rates on Anchor were heavily subsidized. These generous subsidies, the newly minted UST, that were used to pay the interest on Anchor deposits and fund other activities, were the incoherent piece of the puzzle, the breaking point of a protocol that would inevitably lead to unstoppable spiral death. The capitulation did materialize as the volume of deposits skyrocketed the level of subsidies required became increasingly unsustainable until April 2022 when daily subsidy reached $6 million.
In the meantime, a slow and steady wave of critics on twitter kicked the hornets nest until the rumor grew into serious concern for people who parked the retirements in Anchor leading to a panic and the run on Terra happened across multiple chains and assets as a consequence. The run and crash of LUNC was not the result of targeted market manipulation by a single entity, but rather stemmed from growing concerns about the sustainability of the system which led to a total panic in the crypto markets.
At the center of the collapse was Terra’s algorithmic stablecoin, UST, and a blockchain-based borrowing and lending protocol, Anchor. UST was marketed as the first genuine crypto-native stablecoin and was a distinguishing feature of the Terra network.
In essence, the marks of alpha traders derive from their ability to faultlessly interpret the news headlines in crypto markets and counter-trading the widespread emotions/convictions regarding the markets. Psychology at the extremes is a powerful, accurate indicator of turnaround, reversals in price; the emotions are squeezed, stretched near their breaking points and usually when most are about to fold, we stand in reversal zone. This rare ability, contrarian thinking in many regards, will allow you to enter profitable trades before others, a golden ticket to fading parabolic euphoria or panic contagion in an emotional market.