Monday Market Outlook #10
I was stretched out on a massage table in the tattoo parlor (shading in some bands on my arm sleeve) and browsing through Twitter to distract from the pain when it happened.
It felt like the run up to 64k again. People were dumbfounded left and right over Bitcoin's colossal upswing from 33k to 40k in a matter of hours. In Binance's margin perpetual chart, things were even crazier, with Bitcoin hitting 48k for a very brief moment in time.
This is what the short squeeze looked like:
So, how does Bitcoin print an 11k 1-minute candle in the first place? Let's explain the short squeeze.
The Short Squeeze Explained
A short squeeze is a trading phenomenon whereby a particular security, stock, or otherwise asset is considered to be overbought or overextended and a large enough cohort of individuals take a 'short' position on the aforementioned asset. A 'short' is when an investor/trader borrows an asset at a certain price in the hopes that the market value of said asset falls. When exiting their position, they buy back at a lower price using the borrowed asset while pocketing the difference.
So let's go over the psychology; a short squeeze needs two sides: short sellers and contrarians. A short seller sees a broader pullback and looks to take advantage, while a contrarian sees a high short-interest asset and looks to take the opposite bet.
Both are considered risky positions to be sure, but one side will usually be the benefactor of some external stimuli that pushes the market in a defining direction; could be a news article, a strong trend, or an underlying fundamental nuance in the asset.
However, once a short squeeze is initiated — the price of the underlying asset begins to move in the opposite direction of the short seller — they are forced to cover their position OR exit at a loss. To do both is to buy back into the market at higher prices. Covering their position means they are hedging their bet by purchasing the same asset in the spot market to capture the upswing equity and limit the drawdown of their short.
To exit their position means that they must return their borrowed asset at the current price which ultimately means they must buy back higher. Either way, the short sellers only option is to add to the markets decision to go upwards, causing massive volatility to the upside. This then becomes apparent to the broader retail market who then FOMO's into the asset in fears of missing a trend reversal.
So let's discuss the recent Bitcoin short and the external market stimuli that affected investor psychology. I like to break these up in to two camps: the technical and the fundamental.
The cohort of individuals who fall in the 'technical' camp are heavily influenced by indication metrics they find in charts – undoubtedly the larger cohort of the two. This gives them a one-dimensional view of the market denominated in numeric terms and most usually paints a one-dimensional influence on their investment thesis.
For Bitcoin, this meant ever since the broader market pullback from the 64k highs we saw the longest extended period of 'extreme fear' on the Bitcoin Fear and Greed Index in history, the most amount of bearish technical indicators I have ever seen in my life (Wyckoff, H&S, Descending Triangle, etc), and overall sentiment in the overbought camp. Why? Because every market in the United States has been printing All Time Highs this year (Bitcoin included) like it was its job to do so.
A lot of the technical cohort also over-subscribe to the 4-year Bitcoin cycle and that 64k was a broader cycle top, which to be fair could be right. But historically it doesn't compute — the trend does not accompany the thesis of a 64k Bitcoin top in May very well.
When markets are constantly printing highs, investors – rightfully so – predict there is only one way to go: down. While this is most usually the case, this is where the fundamental camp comes in.
The Technical cohort = our Short Sellers.
The cohort of individuals who fall in the 'fundamental' camp acknowledge the information from the technical side of the markets but aren't over-exposed to its influence on their investment thesis. While technical metrics are helpful for defining a broad understanding of the market, the fundamental cohort likes to use this information to confirm or annul bias' using fundamental research.
Fundamental research and understanding could be in a range of things that relate to Bitcoin:
- Macro Economics
- On-Chain Analysis
- Political Influence
- External News
I've gone over the macro outlook several times before in previous Market Outlooks, so we won't cover them in depth.
The recent monetary and fiscal policies around the world have favored those investors who choose to invest in assets with strong macro trends. The most obvious is Bitcoin, but things like tech stocks, certain commodities, and others are set up to do very well in this environment. This is a thought process that, once understood, negates the common misconception that an over-heated market can only trend downwards. You need to understand that these are not normal economic conditions so to invest as if it was is detrimental to your portfolio's growth.
This is all very much overlooked by the technical cohort.
On-chain analysis has been showing us that Bitcoin whales (10-100 BTC & 100-1000 BTC) have been accumulating Bitcoin over the last 60 days. Something often overlooked or missed by the technical cohort.
Political influence in the United States has been somewhat neutral at the federal level with bipartisan stances throughout. The state and local level, however, is resoundingly bullish with places like Wyoming, Texas, and Florida paving the way.
El Salvador puts Bitcoin on the LatAm map with its recent 'super majority' decision to make Bitcoin legal tender within the country. India also back-tracked on their historical opposing stance on crypto by implementing a board of experts to inform future policy on the asset class within India.
Asian countries, however, have been showing a more forceful hand in their recent regulatory crackdown on miners and exchanges throughout China, Korea, and Malaysia. Overall, I see a bullish sentiment in political influence globally and this is also something most likely missed by the technical cohort.
Lastly, and probably the catalyst for the short squeeze, was the Amazon news (whether real or not). On the same day the short squeeze took place, an article surfaced about an Amazon 'insider' claiming the company was to begin accepting Bitcoin as payment before the end of 2021.
The Fundamental cohort = our Contrarians.
The summer months are historically the worst performing months across equities markets and the same can be said for crypto as well. The confluence of that with the recent "hawkish" FOMC hearing at the beginning of summer caused the markets to cool off after an explosive 2020 Q4 and 2021 Q1. In combination with this, Bitcoin experienced a very unique phenomenon I covered awhile back as well, called the Grayscale Effect, in which June and July were to be the most manipulated times of the year.
You add all these things up and it's hard to argue that the Bitcoin pull pack over the last 2 months was only a cool-down. It's only a matter of time before markets begin favoring growth, tech, and speculation once more. Only time will tell, but I hope you got a better understanding of short squeezes, how to research, and where we may be headed.