With sentiment at all-time-lows [counter-balancing the previous all-time-highs] it seems timely to re-visit the dynamics of crowd behavior. As longer-term subscribers are no doubt familiar, I see sentiment, and the manic swings that come with it, as only natural to market speculation. It’s the dynamics of this speculation which is the means by which Bitcoin is capitalized in my opinion, and an understanding of which is crucial for timing one’s optimal entry into the market.
Where many will focus simply on the fundamentals, and thus expect price to ever march onward, my main focus [as a pragmatic investor] has always been on the speculative dynamic. When cognizant of this, it comes as no surprise that two steps forward should also be met with a step backwards, which is where we currently are.
And yet it does comes as a surprise [and a shock] to those who have become overly focused on the fundamentals, or who have simply got caught up in the mania. The remedy to all of this of course is keeping a sober eye on the technicals while also keeping in mind the madness of crowds [as well as the wisdom of them - yes, they can be both].
This article, as do others, goes beyond the strict boundary of technical analysis, always a discipline, and speculates a little in how sentiment, certainly as real as anything else, is related to price. In turn, I’ll look at how this interpretation of sentiment [always the non-rational] can help us in our rational analysis of price, which in turn aids our actions in buying and selling in a more reasonable and sober manner. This in turn should give the investor/ trader that competitive advantage in what is a super volatile market.
1] The Correlation between Sentiment and Price
The chart above shows price correlated to sentiment - the higher the sentiment, the higher the price. If the observer/ follower were not careful, he might simply take this chart to mean that Bitcoin is doing well when both sentiment and price are high, with that being the time to buy. Of course, this is the market reality - most people chase price.
And here is where interpretations of this phenomena will differ. Subscribers to the Efficient Market Hypothesis [EMH] will tend to consider the market as a near perfect pricing mechanism, an aggregate or crowd capable of discovering price beyond the ability of any individual. And of course, the ‘fundamentals’ will always be trundled out in support of this thesis, and to justify current prices - prices may be high, but they *ought* to be even higher for this or that reason. This is the view that markets are wise, the wisdom of markets.
On the other hand, we have quite an opposite interpretation - markets are mad, the madness of crowds. Commentators [Cassandras] here tend to see bubbles everywhere, everything is inflated, and it’s only a matter of time before it all pops and prices crash back down toward reality. The sentiment indicator, for the madness of crowd subscribers, should always be read not simply as a correlation but as an inverse correlation. As opposed to buying when price and sentiment is high, they will run a mile seeing such prices as inflated on ‘hype’ [sentiment].
And yet I think there is a third interpretation here, a third way. It is an all too common trait of human nature to fall into one interpretation or the other. In this binary world, markets must either be perfectly efficient and rational, or completely irrational/ sentimental. I’d suggest instead that the nearer truth is something of a mix between the two. Markets can be both rational and irrational, both wise and foolish though at different times [just as human nature can be, and markets are simply an aggregate of this, buyers and sellers]. If we allow that markets can be rational, and then become irrational for a period of time, we can start to discriminate between high and low prices, that corresponds to high and low sentiment. We can then start to look at the sentiment indicator as inversely related to optimal or rational buying, and as an aid in buying less indiscriminately.
2] Sentiment Inversely Correlated to Ideal Buying Price
And so now we find ourselves half way between the wisdom of markets crowd and the madness of markets crowd. Nor should this be surprising as if you’re to have a competitive edge in the ruthless Darwinian arena of free markets [markets are not your friends… though trends may be], it pays not to belong to a crowd, of whatever persuasion. As I explored further in a previous article:
But of course, all life involves a risk, no matter how much we may be anaesthetized [an-aesthetic] against the perception of it. Mere objective discourse can become that anesthetic, and so too the natural partner of mediocrity - it both leads to and sustains it. But insofar as you’re interested in paths less travelled, you’ll take all such discourse with a heavy grain of salt, as in a sense dissuading you from your own contrary course. Accordingly, an enlightened scepticism will inform all the various persuasions currently existing in the marketplace of ideas. Being literate with many, each discourse may in fact temper the others, and so you’ll be subservient to none in particular. You’ll sift the wheat from the chaff, and appreciate the more useful of them while eschewing the pretensions of the more dogmatic, and of course, the more serious.
Which naturally leads on to…
It’s my hope so far to have established that sentiment [and the sentiment indicator] should be resolutely used, if it is to be used, as a contrarian indicator to your investing/ trading decisions. When sentiment is high, a note of caution is to be struck, and though this may not be definitive in your decision-making process, it will certainly carry some weight. Why not definitive? Why cannot we not just simply do the opposite of what sentiment is saying? Because the fact of the matter is that sometimes we want to be going with the flow of the market, with the greater trend, even though if most of the time we want to be going against it* [note that in late 2020, it paid to go with the sentiment in the above index].
Once again, the danger here is one of creating a simple narrative such as ‘always be contrarian to market sentiment’ to replace ‘markets are always wise’ or ‘markets are always mad’ [that said, I’d hazard a guess that even such a blanket contrarianism would outperform a purely sentiment-driven trader/ investor].
Of course, the pragmatic contrarian wants to take advantage of mass speculation in the marketplace. Whereas the easier part will be to enter, the more difficult part will be to exit at the most opportune moment… on the mania. This is because once markets go manic, there is no telling how high they could rise before ‘popping’ or correcting [see ‘Is Bitcoin really a Bubble’ article for further on this]. In this sense, the contrarian’s positions/ trades are not always contrary to the majority of the market. Most of the time, say two thirds, they’ll be long just as most of the market is. Rather, it’s their sentiment that will always be contrary to the market’s. Behavioral economics comes to the fore here - the contrarian, not driven by passion but rather guided by an enlightened skepticism, and so not swept up in the prevailing hype and hysteria, will be able to coolly press the sell button when in doing so it would represent real and tangible gains.
Given this passage, it is clear that what defines the contrarian is not so much a blanket opposition to the market per se, but a psychology that is not ‘sentimental’. It is a psychology that is not prone to being completely defined by market sentiment. Of course, given we are market participants and social [media] animals, this will always be a process, and a difficult one. The key here, in my opinion, is to keep a tension between the outlook of the sentimental many, and a more critical and rational distancing from that outlook. And this is the basic outlook that underlies the idea of hedging.
But Dave, the reader might by now be asking, how does this theory practically relate to our trading/ investing? To which the following section is addressed.
4] Using the Sentiment Index as an Aid to Investing/ Trading
The irreducible fact of the BTC market [if it wasn’t crystal clear before has certainly become so now] is super volatility. What seems a truism on the face of it makes all the difference for even longer-term investing - one’s entry point is crucial.
This is something I looked at in an earlier article when price/ sentiment was higher:
If the curve is said now to consist primarily of speculative episodes, now that the market is maturing, then the lower and upper parameters of that curve can be said to reflect market sentiment [psychology again] as it swing between the ‘FOMO’ of inflation expectations and the ‘FUD’ of deflation expectations. What’s of interest to note is that the lower range effectively grounds, or solidifies, the speculative excess [without which this burgeoning currency could not be capitalized].
With FOMO and FUD being the ‘yin and yan’ of sentiment [and given that more ideal entry points are made on FUD/ deflation expectations], and with sentiment now at all time lows, then you have an argument here adding weight to the proposition that the current time may be an opportune time to buy [notice here that my language is not definitive or dogmatic; due to the uncertainty principle, risk can never be completely eliminated… but it can be reduced].
And so another look at the sentiment index, and through the interpretative lens of the more contrarian and critically-minded investor/ trader.
Currently, we have the color-coded index pushing all time lows. As an indicator that is inversely correlated to [previously] ideal buying price, it is actually reading as a positive for buying as opposed to what the more conventional wisdom might see as an extreme negative.
And this also lines up with the technicals of the long-term LGC [logarithmic growth curve], which identifies the optimal buying zone at the lower channel the base of the curve. The technicals also allowed for the possibility of price exploding to the top [our ‘anomaly’ of the sentiment index, where it paid to simply follow it]. Where price is currently situated, you have the ‘stars’ aligned, both sentiment [as a contrarian indicator] and the technicals [along the lines of a model that has performed since 2018]. Accordingly, you’ve a good spot to buy… within reason.
The sentiment index lines up with the well-known adage of ‘buying when there’s blood in the streets’. Of course, to be objective [or critically distanced from sentiment], the prospective buyer has also to be cognizant of the equally well-known adage of ‘beware of catching falling knives’. There is no simple or complete answer here to assuage the anxieties of those on the side-lines. A modicum of risk will always remain, and the buyer has to manage that risk in the end for themselves.
And yet the main point of this article is to remove sentiment, as it currently stands, from the negative side of the balance [wherein the rational decision-making process is made] to the positive side. It’s been my aim to show that sentiment as it currently stands should, at the very least, not be the decisive factor keeping one from buying. Looking at it rationally, insofar as one’s own sentiment is bracketed out of the equation, it should contribute, if it is to contribute anything, to a policy of buying, now that the recent ‘speculative episode’ has subsided with price back to its long-term trend.
Until next time,
Stay [relatively] safe out there,
Dave the Wave.
* The contrarian trader, who sees the market akin to something like a ship of fools [and himself as potentially one among them] that first lurches one way in the mass, and then lurches the other on the over-correction.. and yet the ship still has a direction [the greater trend].