Stock markets and investment markets, including the world of cryptocurrencies, have always been characterized by high dynamics and volatility. This means that as often as they bring enormous profits, they also lead to sharp losses. History has witnessed many cases where investors bought stocks at inflated prices during a bull market, only to panic and sell them during market crashes. Why does this happen? In this article, we will examine the reasons behind these phenomena.
Investor psychology – emotions over rationality
As we know, humans have always been social beings. It’s natural for us to act in groups and follow the crowd. Often, our decisions are influenced by the actions of others. However, in the context of financial markets, this instinct can become our enemy. During times of rising enthusiasm in the world of cryptocurrencies, there is a tendency to abandon our own analysis in favor of the “herd effect”
Speculative bubbles, such as the one involving internet companies at the turn of the 21st century, are perfect examples of this. Investors poured their capital into internet technologies in mass, ignoring the real value of these businesses. Unfortunately, when confronted with the reality of the market, many companies experienced massive financial losses.
Therefore, it is crucial to remember to prioritize your own convictions when investing in cryptocurrencies. Of course, analyzing and observing the actions of experienced investors is valuable, but it should not overshadow rational and individual assessment of your investments.
Greed vs. fear
In both the cryptocurrency market and traditional investments, emotions play a significant role. Greed and fear often take center stage and can lead to unfortunate outcomes, such as substantial capital losses.
During bull markets, when prices are rising, investors often feel confident and see only promising prospects ahead. The vision of quick profits can overshadow any concerns. Greed becomes the dominant emotion at this moment, and the risk of capital loss is unfortunately underestimated.
A good example is the cryptocurrency bull market during the Bitcoin surge in 2017. BTC prices were skyrocketing, and investors believed it was the perfect opportunity for sudden wealth. Consequently, many did not thoroughly analyze cryptocurrency projects or consider their long-term value. Sadly, some of these projects failed, and investors suffered significant losses.
What about fear in the crypto world? In moments of market panic, investors often act impulsively, seeking to quickly divest their assets. However, dominant fear can cause them to sell their investments at the worst possible moment, contributing to further price declines.
An example of fear in the context of the cryptocurrency market is the crisis caused by the COVID-19 pandemic. In March 2020, as the pandemic spread worldwide, cryptocurrency markets experienced sharp declines. Many investors, alarmed by the situation, decided to sell their cryptocurrencies immediately. It turned out to be the worst thing they could do because prices rebounded significantly just a few months later.
Lack of education and experience
The cryptocurrency market is complex and unpredictable. Without the right knowledge and experience, it’s easy to make mistakes. A prime example is the stock market crash in 1929. A wave of new investors was drawn in by stories of unlimited profits and investing on credit. Unfortunately, many of them did not understand the real mechanics of the market, leading to bankruptcy when the market collapsed.
What else contributes to investment mistakes? Inadequate education is a significant factor. In the digital age, we are bombarded with information from all sides. While access to knowledge has never been easier, it doesn’t mean that everything we read is true. Too often, investors make decisions based on unverified information, rumors, or the opinions of media “experts” who may not necessarily be competent. This is why it is essential not only to continuously educate oneself but also to critically assess the information acquired and constantly seek reliable sources.
The trap of over-reactivity
In digital currency markets, daily price fluctuations that seem to change without clear reason are common. This factor often provides a playground for emotional reactions from investors. One of the most common mistakes made by cryptocurrency market participants is reacting to these short-term market movements.
The trap of over-reactivity involves making hasty investment decisions due to an emotional response to current market events. When the price of a particular cryptocurrency is rapidly rising, investors often become enamored with the prospect of quick profits. At this point, emotions such as greed can override rational judgment. Instead of calmly analyzing the situation, investors follow the crowd and buy assets at inflated prices. This scenario resembles emotional reactions seen during bull markets.
An example? The frenzy in the DeFi (Decentralized Finance) market in 2020.
DeFi is a cryptocurrency sector where projects offer financial services without traditional institutions. Within a few months, many DeFi projects gained popularity, and their tokens experienced significant price increases.
In this environment, investors, driven by euphoria, wanted to seize the opportunity and bought DeFi projects without proper analysis and without understanding the risks involved. Initially, everything seemed to be going up. Unfortunately, there came a point where the market started showing signs of “overheating” and some projects fell victim to hacks or other issues. As a result, the prices of many DeFi tokens plummeted, and investors who bought at the peak suffered significant losses.
The trap of over-reactivity is a common investment mistake that can lead to losses. Awareness of this trap and applying appropriate investment strategies, such as risk management, maintaining composure during sudden price movements, and having long-term financial visions, can help investors avoid unfortunate decisions and succeed in this challenging market.
Understanding investor behavior during bubbles and crashes is crucial for avoiding such mistakes. Education, independent analysis, and long-term thinking are just some of the tools to combat market traps. Remember that the history of financial markets is full of ups and downs. Learn from past events to minimize the risk of becoming another victim of bubbles or crashes in the world of digital assets.