Investor Psychology: Market Crashes

I'm sure you're all well aware of the recent crashes we've seen in crypto and the stock market.

I have received multiple messages from people asking me if BTC will 'go back up' and if crypto is a 'scam'.

This is the mindset of 'dumb money', the mindset of the masses. We are adopting the mindset of 'smart money', so we must learn to see the markets from a whole new perspective.

What Are Crashes?

Crashes or 'dips' are events where the price of an asset significantly decreases within a relatively short period of time, eg. 10% decrease in 1 month.

From the perspective of dumb money, this is scary. They panic, worry, and might even go as far as to panic sell their holdings to limit the amount of capital they lose. 

Panic sell: when fear has taken over and forced one to sell one's assets.

Understand this: you do NOT lose anything unless you sell.

Drawdown is not the same as loss. Drawdown is simply when you currently have a negative ROI (return on investment). For example, you may buy BTC today and it drops 10% from the price you bought at. You are then in 10% drawdown, but this means nothing unless you sell. If you hold and price increases to the original price you bought at, you now have 0% profit or loss on your investment. Drawdown only affects your capital if you sell. Otherwise it means nothing.

Are Crashes A Bad Thing?

Yes and no. But, mostly no. 

Looking at a crash at face value is not enough, it is imperative you understand WHY an asset's price has crashed. Understanding why will help you understand the true state of the asset.

For example, if the asset's fundamentals are great and its price dips, it's more than likely because of the technicals.

There are two factors that govern the price of an asset; fundamentals and technicals.

Fundamentals: the basic qualitative and quantitative information that contributes to the financial or economic well-being of an asset and its subsequent financial valuation.

- In English, fundamentals are the core factors of the asset; technology, whitepapers, partnerships, owners, balance sheets, cash flow, revenue, profits, etc. Depending on the asset, it will have different fundamentals.

Technicals: an asset's price and volume action.

So going back to what I said about fundamentals being great but price dipping, it's probably because of 'price manipulation' rather than because there is something negative about the asset fundamentally.

Price manipulation: where smart money manipulates the price of an asset to capture liquidity in the market and capture lower prices of an asset.

However, if the fundamentals of the asset have taken a turn to the negative side, this can also cause a crash or dip in price as investors will want to protect their capital and will withdraw their investments.

For example, if a consistently profitable company starts to lose profit year on year, investors may sell off shares thus leading to a decline in price.

So, it's important to analyse the asset to determine whether the crash is 'bad' or not.

Can Crashes Be Good?

Now for the juicy bit.

YES.

Crashes can be fucking amazing. Seriously, they can provide incredible opportunities.

If the price of an asset has crashed due to smart money manipulation, our institutional friends are providing us with opportunities to buy into the asset at lower prices thus giving higher ROI when price increases in future.

For example, a stock rises 10% year on year, if you buy on 1st Jan you will have made 10% profit in exactly a year's time. However, if you cost average into the asset over the year and capitalise on the dips in price, you could potentially double your end of year ROI to 20% or even higher as your average purchase would have decreased thus allowing for a higher profit even if the assets year on year increase was still 10%.

So, if your favourite assets have dipped or crashed in price and the fundamentals are looking good, you have been blessed with an incredible opportunity to get more out of your investment.

Crashes are buying opportunities. Don't be scared, be excited.

Until next time.