Crypto Market Cycles

MORITZ PUTZHAMMER

16 October 202211 min read

Table of contents

Life cycles, election cycles, billing cycles, sleep cycles, and even vicious cycles. Although there seems to be an endless number of them all around us, as crypto traders we’re only really interested in one specific type: market cycles.

Imagine being able to take the guesswork out of trading. Although it might sound impossible given crypto’s volatility, there is a systematic approach to trading that can be used to your advantage. By learning to identify the cyclical structure of prices, you’ll be able to make accurate predictions about future price movements, unlike so many of those amateur YouTube clairvoyants and their clickbait price prediction videos.

But what exactly are cycles? Can you actually predict them? And what happens when there are cycles within cycles? It can all get very complicated very quickly, which is why it’s absolutely essential to understand how crypto markets move in order to use market cycles to make consistent profit.

In the following article, you’ll learn how to demystify market cycles by identifying their specific phases. In order to trade like a professional, you need professional-grade methods such as multiple time-frame analysis as well as a healthy understanding of cycles within cycles. When armed with this knowledge, you’ll be able to spot the longer-term trend, which will be your insurance during rough market patches such as a crypto winter or bear market.

Let’s start off with the basics.

What are cycles and how to identify them?

As Howard Marks writes in Mastering the Market Cycle, traders should think of cycles as a swinging pendulum—the reasons for the movement will vary, but the movement itself will go on occurring forever. He further clarifies his point:

The cycle oscillates around the midpoint. The midpoint of a cycle is generally thought of as the secular trend, norm, mean, average or “happy medium,” and generally as being in some sense as “right and proper.” The extremes of the cycle, on the other hand, are thought of as aberrations or excesses to be returned from, and generally they are. While the thing that’s cycling tends to spend much of the time above or below it, eventual movement back in the direction of the midpoint is usually the rule. The movement from either a high or a low extreme back toward the midpoint is often described as “regression toward the mean,” […]. But it can also be seen that the cyclical pattern generally consists as much of movement from the reasonable midpoint toward a potentially imprudent extreme as it does going from an extreme back toward the midpoint.

To become an effective crypto trader, you need to possess a sound understanding of how crypto markets move and how to use market cycles to make consistent profit. If you learn how to identify them, crypto market cycles can reveal important information, such as when you should buy or sell.

The Four Phases of a Crypto Market Cycle

Unlike traditional assets such as stocks or bonds, cryptocurrencies are highly volatile, meaning that you’ll want to try to stay on the right side of them. Things can go south very quickly, with many investors getting caught off guard when the market crashes. To avoid being sucked into a crypto market sinkhole, it is absolutely vital that you understand how market cycles work.

The Accumulation Phase

The accumulation phase is a stage of consolidation after a decline in price over a longer period of time. The price at this phase is usually trading in a range.

Mark Up Phase (Bull Market)

The run-up phase (it can also be referred to as a bull market when looking at the market as a whole) is when the market begins to move to higher highs at an increasing rate. This is the time when the market direction has become clear and overall market sentiment has changed to optimistic.

The end of this phase happens when most market participants have bought as much as they can, and then they will eventually be forced to take profit and become sellers.

As prices begin to level off, this leads the market into the distribution phase with the final wave of investors jumping in. This is where excessive gains are seen in very short periods and it's where the media attention on the market is at its all-time high.

Distribution Phase

In the third phase of the market cycle, the price plateaus and sellers begin to dominate. This part of the cycle is identified by a period in which the bullish sentiment of the previous phase turns into a mixed sentiment. The price will seem to plateau as trading occurs within a narrow range, which can last days or weeks, and the price momentum slows down.

This phase concludes when the market reverses its direction. Classic technical analysis patterns such as head and shoulders or double or triple tops can be found during this phase as well, indicating a change in direction.

Since this phase marks the peak (top) of the market, it’s a period overrun by emotion. The majority of the market looks to the recent past with hopes of continued excessive gains, with greed overtaking common sense. It’s a time where smart money has already exited and where equal parts of anticipation and fear surround the market.

Mark Down Phase (Bear Market)

The last phase of a market cycle is the run-down. For the majority of investors, this is the most difficult period and a highly emotional time, as they either are not aware of the permanence of market cycles or choose to ignore them, resulting in either selling too late or not selling at all.

The stages of a price cycle and its relation to position accumulation and distribution.
The stages of a price cycle and its relation to position accumulation and distribution.

Forecasting and Cycles Using Indicators

Understanding cycles is fundamental to price forecasting because cycles tend to have a predictable structure. The sequence of accumulation, mark up, distribution and mark down is regular and predictable and this activity introduces patterns into prices. The cyclical structure of prices enables you to make predictions about prices assuming they continue to follow their previous cycle.

Knowing where the price is in the price cycle is important, which is why you need to ask yourself: How can you measure where prices are in the cycle? Thankfully, trading indicators can help to answer this question.

Quite simply, indicators are mathematical formulas that use information such as market prices and volumes to measure certain characteristics of the market. Outputs from trading indicators can be combined to decide if prices are more likely in the top or bottom of a cycle and if the trend or momentum has recently changed. Indicators are useful for measuring what has recently happened. In other words, understanding cycles will allow you to predict what is likely to happen next.

One of the biggest drawbacks to trading indicators, though, is that they are only able to measure the past. Trading indicators are computed using historical data and for this reason indicators have lag. By understanding the cyclical nature of prices and the interaction of cycles over different time frames, it is possible to make predictions about the future by using indicators to measure where in the current cycle prices are.

Chart showing the lag associated with indicators
Chart showing the lag associated with indicators

To better illustrate how an indicator can be used to identify where we are in a cycle, we can examine the relative strength indicator (RSI), which is an oscillator—meaning its value is bound between 0 and 100. Oscillators tend to have cyclical dynamics due to the bounded nature of their values. When the RSI is low, the expectation is that if the price is currently at the bottom of a cycle, then the most likely thing to happen next is for prices to rise as the price moves to the top of the cycle.

If you implement a long-only strategy, it is important to identify times when the price is about to rise. Using the theory of cycles, the time to buy is when the price is at the bottom of a cycle. Regarding the RSI indicator specifically, the assumption is that when the RSI value is low, the price is at a low of the cycle. Thus, identifying times when the RSI value is low can indicate when the price is also relatively cheap and presents a buying opportunity. The plot below shows the relationship between the prices and this RSI history.

Chart showing the lag associated with indicators
Chart showing the lag associated with indicators

This principle can be used with many different indicators. If a strategy favors high volatility, often indicators will target times when volatility is low but rising. The expectation is that high volatility follows low volatility, so the strategy only needs to know where it currently is in the cycle to predict the future.

Cycles within Cycles

If cryptocurrency prices looked like a sine wave, then trading would be much simpler. In a trading exchange, however, prices are set through the interactions of many participants, each with differing constraints and objectives. This activity leads to more complex price dynamics, which to the untrained eye can look chaotic. The price dynamics are, however, simply different cycles that interact with each other on different timeframes.

The hierarchical nature of cycles is important for trading, since being able to identify the primary cycle can give you an indication about the long-term price direction. The medium-term cycle is useful for identifying whether the price is in an area of value from which taking a position would be advantageous. Shorter-term cycles are often useful for timing and confirmation of the original trading hypothesis.

1D chart of BTCUSDT showing long-, medium- and short-term cycles.
1D chart of BTCUSDT showing long-, medium- and short-term cycles.

The chart above illustrates the closing prices of BTCUSDT from 4 July 2021 to 7 November 2021. The purple line represents the longer-term trend. There are smaller cycles represented by the green line, which mean revert to the longer-term trend. The red line represents even shorter-term cycles, which tends to revert to the green cycle line. The longer-term cycles are normally dominated by larger companies that likely hold long-term positions. The short-term cycles are dominated by shorter-term traders looking to make smaller and quicker profits.

How to Trade Cycles Within Cycles

Now that you know about the different crypto market cycles, you’re likely wondering how you can leverage this knowledge and take profits from the market. The fractal nature of markets means that prices tend to follow cycles within cycles. For this reason, it is advantageous to design strategies to analyze long-, medium-, and short-term cycles separately.

For example, if a hypothetical strategy only uses 1 hour time bars, the prices may look relatively cheap, prompting the trader to consider buying. The strategy, however, might overlook a few things: the price might be in a long-term bear market; on a longer-term basis, the prices might be at all time highs, and so unlikely to go higher; or, in the short-term, the momentum might still be strongly negative, indicating prices could go down even further.

These issues can be solved with multiple time-frame analysis and the concept of cycles within cycles. The general idea is to have a position that is synchronized with the long-, medium- and short-term traders because this provides the best risk adjusted returns. Another opportune time to buy is when all other actors in the market are either long or buying.

Multi-time frame analysis is the application of indicators for measuring price cycles across multiple periods of time, making it possible to determine the likely behavior of long-, medium-, and short-term traders simultaneously.

This longer-term trend can be thought of as the position’s insurance. Large investors (known as whales) determine the larger price moves, which is why it’s important for positions to be in the same direction as the dominant trend in order to take advantage of these price moves. That’s the thinking behind the well-known adage the trend is your friend. If done correctly, the probability of a significant drawdown should be low.

The second step is to identify the behavior of medium-term traders. Often in a bull market, the price can temporarily move lower, which can be due to profit-taking or other activity caused by constraints on traders. When the price moves opposite to the primary trend, otherwise known as a pullback, it can offer great trading opportunities. By identifying pullbacks, your aim is to measure price cycles on a medium-term time horizon and look for relatively cheap prices.

The final stage before sending an order is to identify the activity of short-term traders. This signal is known as the trade trigger. When the price is in a pullback, the short-term momentum is against the trend. Before taking a trade, it is essential that short-term momentum is complete and prices are about to continue in the direction of the primary trend. The trigger tries to time the trade by measuring the short-term momentum to determine when the pullback is likely to be complete. This trigger signal improves trade timing and aims to reduce the short-term losses associated with a position before it becomes profitable. If your strategy has good timing, it will also have good risk-adjusted returns.

The following code example demonstrates a combined signal consisting of the layering of a trend with setup and trigger signals. As a good exercise, you can modify the code and look at using different indicator combinations to achieve profitable trades as well as trades with good trade timing, i.e., high risk-adjusted returns.

Python code
Python code example demonstrating a combined signal consisting of the layering of a trend with setup and trigger signals.

As a crypto trader, you should always work towards gaining a better understanding of why cycles exist, how they are layered, and what their importance is within market regime forecasting. This knowledge, in turn, will also help when learning about different indicators and how they should be used to maximize their utility.

Conclusion

Unlike traditional assets such as stocks or bonds, cryptocurrencies are highly volatile, meaning that you’ll want to try to stay on the right side of them. Things can go south very quickly, with many investors getting caught off guard when the market crashes. To avoid being sucked into a crypto market sinkhole, it is absolutely vital that you understand how market cycles work.

In this article, we focused on a range of important issues related to understanding crypto markets, such as:

  • Understanding market cycles and how the predictability of cycles gives prices predictability;
  • The relationship between indicators and market cycles and how the interaction of heterogeneous market participants causes cycles within cycles;
  • And, finally, how trading indicators can be layered to estimate the correct time to trade by predicting when the long-, medium-, and short-term cycles are in sync.

In summary, becoming a good trader involves acquiring a sound understanding of how crypto markets move and how to use market cycles to make consistent profit. Understanding cycles is an important aspect of price prediction and forecasting because cycles tend to have a predictable structure.

The cyclical structure of prices can enable traders to make predictions about prices. Multiple time-frame analysis and the concept of cycles within cycles can be used to identify the longer-term cycle and the current price trend.

However, understanding crypto market cycles is vital to successful trading, but it’s only one tool among many. When paired with an automated algorithmic trading strategy based on crypto trading bots, you can weather challenging market conditions and even accumulate a wealth of knowledge and experience in the process, priming you to take advantage of the next market cycle in a reliable, precise, and profitable manner.