Crypto Volatility: Identifying Corrections and Crashes
The ups and downs of the crypto market often make traders and investors nervous, leading to discussions about the possibility of a market crash. Amidst the worries and concerns about a potential downturn, it’s important for investors to understand the terms commonly used — like market crash, correction, and meltdown.
The significant rise of Bitcoin in 2017, followed by a 65% drop in its price from January 6 to February 6, 2018, is a notable example that triggered alarms and prompted questions about whether the market had really crashed. This article aims to explain the difference between a crypto market crash and a correction.
Understanding the Terms
The language commonly used to describe market declines, including terms like “market sell-off,” “meltdown,” or “crash,” is often emotionally charged and lacks precision. To enhance clarity in discussions about market downturns, it is important to emphasize two specific terms: “correction” and “bear market.”
Typically, a correction is defined as a decline of at least 10 percent from a recent peak, indicating a natural and potentially less disruptive cycle in the crypto markets. On the other hand, a bear market is characterized by a decline of 20 percent or more. While corrections suggest temporary setbacks, bear markets can dampen investor sentiment, leaving them uncertain about when the downward trend will reverse.
Differentiating Between Crypto Market Crashes and Corrections
Several effective methods for distinguishing between a market crash and a correction involve analyzing fundamental factors like regulations, economic conditions, and macroeconomic indicators. Additionally, employing technical indicators such as Fibonacci retracements and the Relative Strength Index (RSI) can assist in discerning whether the current market movement is indicative of a crash or a correction.
1.Economic Data and Market Trends
Examining economic data is another essential aspect of distinguishing between a market crash and a correction. Currently, various indicators point to a healthy economy, including low unemployment rates and robust GDP growth. It is crucial for investors to consider the broader economic context when assessing market downturns.
Historical data reveals that crypto assets such as bitcoin have experienced a 10 percent drop from their peak in two out of every four years since 2012. Despite these periodic setbacks, the market has rebounded in most years, emphasizing the resilience of the financial markets. This resilience is often driven by underlying economic strength, which provides a solid foundation for the markets to recover and resume an upward trajectory.
2. The Golden Ratio and Market Corrections
The 61.8% Fibonacci retracement level, often referred to as the golden ratio is a key resistance level for Bitcoin. This level has historically triggered retracement pullbacks in cryptocurrency. The first major difference between a market crash and a correction lies in the technical levels that trigger these movements.
A correction is often initiated by reaching a predefined resistance level, such as the golden ratio. This type of retracement is considered healthy market behavior, allowing for a temporary pullback before potentially resuming the upward trend. It reflects a market reassessment, preventing unsustainable parabolic growth.
3. Monthly RSI and Structural Levels
The Relative Strength Index (RSI) is another important indicator. An overbought RSI, as observed in Bitcoin’s monthly charts, historically precedes market corrections. The second distinction between a correction and a crash lies in the duration and extent of the RSI overbought condition.
In a correction, the overbought condition is seen as a sign of caution, prompting a pullback to more sustainable levels. However, if the RSI remains overbought for an extended period, it may indicate a more severe correction or the beginning of a potential market crash.
4. Breaking Structural Levels and Pulse Momentum
Key structural levels around the 11,000 levels are also some important gauge and breaching these levels serves as a third indicator of a potential correction. Here, the difference between a correction and a crash lies in the nature of the breach.
In a correction, breaking structural levels is seen as a natural part of the retracement process. It allows the market to reevaluate its position before potentially continuing the upward trend. Conversely, in a crash scenario, breaking such levels may indicate a more profound shift in market sentiment, potentially leading to a prolonged downturn.
Analyzing the monthly pulse momentum suggests another reason for anticipating a correction. The distinction here is in the nature of momentum decline. A correction sees a gradual reduction in momentum, reflecting a healthy market adjustment. Conversely, a crash may witness a sudden and drastic loss of momentum, signifying a more substantial market upheaval.
5. Three-Step Correction and Moving Averages
Three-step correction pattern, akin to a zigzag or ABC movement down to key moving averages, is another important gauge. This introduces the concept of corrective market behavior, where the market seeks equilibrium by retracing towards established support levels, such as the 21-weekly average or the 100-daily moving average.
The distinction between a correction and a crash becomes evident in the orderly and gradual nature of a three-step correction. If the market can hold these key moving averages, it signifies a healthy correction and reinforces the potential for a continued upward trend. On the contrary, a crash scenario would involve a breakdown below these support levels, leading to a more extended and severe downturn.
Wrapping Up
In times of crypto market volatility, investors must distinguish between a market crash and a correction. Being aware of these terms enables informed decision-making based on market conditions, economic data, and sentiment. Corrections are viewed as normal fluctuations, whereas a bear market demands heightened caution due to prolonged downturns. It is crucial for investors to navigate these distinctions wisely to make sound financial choices.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.
