Digital Nugget: Bull market corrections

Corrections during a crypto bull market can be quite severe, especially by the standards of traditional markets, and they can sometimes last many months. However, as long as the bull cycle is in place, corrections represent buying opportunities.

The uptrend of bull markets is interspersed with periods of price corrections and consolidation. Corrections are healthy as they remove excessive leverage, establish support levels and broaden participation by creating opportunities for potential buyers who missed the prior upmove. 

What is a typical bull market correction like? 

Due to the greater volatility of the crypto market, what is considered a bear market in equities – a downmove in excess of 20 percent – is a mere correction in the crypto market. 

To account for the difference in volatility, we define crypto bear markets as a drop greater than the average three-month historical volatility, i.e. one standard deviation. Downmoves short of this but in excess of ten percent are considered corrections. 

During crypto market bull cycles, there is usually a severe correction before the final exponential phase of the cycle, but several corrections tend to occur during the various phases of the bull market. We define these phases as the initial recovery from the bear market lows, an extended period of a sideways, low-volume market with low conviction in the recovery, followed by a growth phase when momentum accelerates to the upside and a final exponential phase of exuberance.  

We looked at the frequency, severity and duration of corrections during past crypto market bull cycles using Bitcoin as a proxy for the market, as its 15-year history allows us to observe cycles while broad market indices have a much shorter history. 

Average depth and length of corrections during Bitcoin bull market cycles 

        Source: CoinMarketCap, Sygnum Bank 

Historically, crypto bull markets have seen an average of nine corrections per cycle, with an average drawdown of -23 percent and a 2.5-month duration. The low conviction phase of bull cycles typically has longer and deeper corrections (-30 percent and lasting over four months), and the final exponential phase has the least severe corrections (-15 percent) that on average last just 1.5 weeks. 

How does the current cycle compare? 

Corrections in the current cycle have been shorter and milder than the historical averages. This is expected, as crypto market volatility is trending down over time and the magnitude of the corrections becomes smaller. The time periods between corrections have also been getting longer, suggesting the corrections may be becoming less frequent. 

We are in the fifth correction in the current cycle, and with a -20 percent drawdown, it is slightly milder than the long-run historic average. The current correction started on 13 March, lasting slightly over two months, and it is close to ending on the catalyst of a reported improvement in the regulatory approach to crypto in the US.  

How do corrections end? 

While it is easy to observe historical corrections, it is hard to predict either their onset or their end in real time. However, there are certain signals that suggest the end of a correction may be near. 

As corrections are primarily driven by short-term holders, a useful signal is to track whether short-term holders are in profit. Seller exhaustion of short-term holders tends to occur when their average purchase price is below the market price again. Once selling pressure from short-term holders abates, the price can accelerate to the upside again on catalysts or buying pressure. 

The correction may end if an important fundamental catalyst appears. Alternatively, the uptrend may resume simply because selling pressure fizzles out. One sign of buying pressure without offsetting selling pressure is when the market moves up in the face of neutral to negative newsflow. 

How to trade corrections 

Corrections during bull markets are normal and necessary. They have, however, been shown to generate net losses for active investors because of the psychological phenomenon of recency bias – the expectation that the most recent trends will continue. The whipsaw effect of reversals – both at the start and the end of the correction – often creates losses in actively traded portfolios. Quantitatively traded portfolios are just as vulnerable to this effect, if not more, as algorithmic trend and momentum models are based on recency bias. 

As market trends tend to persist, corrections in bull markets tend to resolve to the upside, and crypto market cycles have historically been quite analogous and predictable. In addition, a major proportion of crypto investors are convinced of the long-term crypto megatrend and remain holders, undeterred by corrections or even by extended bear markets. 

Bull market corrections ultimately offer attractive entry points for new investors and the opportunity to average in and add to positions for existing investors. Those who wish to actively trade market corrections by reducing and increasing positions can use signals such as seller exhaustion of short-term holders or the market moving up on negative news to time the end of a correction, keeping in mind that a major fundamental development can always trump the signals.

Read more about crypto assets from Sygnum here.

Disclaimer: The information in this publication pertaining to Sygnum Bank AG (“Sygnum”) is for general information purposes only, as per date of publication, and should not be considered exhaustive. This publication does not consider the financial situation of any natural or legal person, nor does it provide any tax, legal or investment advice. This publication does not constitute any advice or recommendation, an offer or invitation by or on behalf of Sygnum to purchase or sell any assets. No elements of precontractual or contractual relationship are intended. While the information is believed to be from accurate and reliable sources, Sygnum makes no representation or warranties, expressed or implied, as to the accuracy of the information. Sygnum expressly disclaims any and all liability that may be based on such information, omissions, or errors thereof. Any statements contained in this publication attributed to a third party represent Sygnum‘s interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party. Sygnum reserves the right to amend or replace the information, in part or entirely, at any time, and without any obligation to notify the recipient of such amendment / replacement or to provide the recipient with access to the information. Simultaneously, there is no obligation of Sygnum to inform recipients of information, if before provided information later becomes outdated, inaccurate or obsolete, unless otherwise provided by applicable law. The information provided is not intended for use by or distributed to any individual or legal entity in any jurisdiction or country where such distribution, publication or use would be contrary to the law or regulatory provisions or in which Sygnum does not hold the necessary registration, approval authorisation or license. Except as otherwise provided by Sygnum, it is not allowed to modify, copy, distribute or reproduce, display, license, or otherwise use any content for commercial purposes.

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