Crypto gains momentum as markets eye Trump election – four things to consider before you invest

Trump speaking at the Bitcoin 2024 Conference in Nashville, Tennessee. Associated Press / Alamy Stock Photo^[8]

1. Momentum and reversal effects

Buying crypto stocks that have recently performed well and short selling^[9] (selling shares that are falling in value, and then buying them back later at a reduced price) those that have performed poorly is often considered a potentially profitable strategy.

When buying high-performing stocks, investors anticipate that the positive trend will continue, leading to further price increases. And, in the same vein, investors expect prices to continue declining when short selling those that are performing badly. In crypto circles, as well as in finance more generally, this is called the momentum effect.

However, finance theories^[10] suggest that the complete opposite strategy can, in some instances, yield even better returns. Stocks that are performing well could also be seen as close to exhausting their growth potential, suggesting that a decline is likely to follow.

So, some investors may instead buy poorly performing stocks in the expectation that their price will rebound. This strategy, which is called the reversal effect, aims to generate substantial profits as the market corrects itself.

By targeting poorly performing cryptocurrencies, large investors in particular can help increase liquidity^[11] for these assets. Liquidity can be measured simply by trading volume^[12] – the more active traders there are in the market, the easier it is to buy or sell the asset. This should enable greater growth potential.

Bitcoin is performing well in anticipation of a Trump victory. But amateur investors should be aware that larger institutional investors may employ different tactics. It is also important to consider that even robust-looking trends can be reversed at any moment.

2. Salience and recency biases

Events like a US presidential election attract the attention of investors, partly due to something called salience bias. Various studies suggest^[13] that crypto investors, in particular, tend to focus on a prominent event or a piece of information that is emotionally striking.

Rational investment decisions should be based on a balanced assessment of the risk and return of investment assets. But, during an election, crypto investors’ attention is likely to be narrowly focused on polling data or media coverage of the candidates.

For newer and less mature markets like cryptocurrency, a reliance on easily accessible information is more common than conducting sophisticated analysis of the underlying financial metrics or economic indicators (fundamentals^[14]). This is risky, as all other less prominent yet important information can be easily ignored.

The history of cryptocurrency shows numerous collapses, demonstrating the vulnerability of cryptocurrency^[15] as an asset class. In November 2022, for example, the collapse of FTX^[16], a leading crypto exchange, triggered a major collapse across the entire crypto market. This included a significant decline in Bitcoin’s price.

A billboard in Times Square showing live election odds on October 10. Artist Nadia Russ / Shutterstock^[17]

3. Lottery preferences

Cryptocurrency markets are subject to significant speculation. Investors hope for big wins, even if the chances are slim. Similar to buying a lottery ticket, investors may buy assets^[18] driven by the illusion of lucrative future profits.

This is, of course, also true for some investments in traditional markets. But stories of Bitcoin millionaires^[19] and how they quickly made their fortunes create the illusion of the possibility of becoming rich quickly.

Such successes are not necessarily replicable in current market conditions. Regardless of the election outcome, cryptocurrency markets will remain highly volatile, speculative and risky. Just because some people win the lottery does not mean that you will.

4. Anchoring effect

Another behavioural anomaly typical of cryptocurrency markets is the anchoring effect^[20]. This is where investors accept and cling to the “anchor” of the first piece of information they receive. For example, if they read an article stating that Bitcoin’s price will rocket after Trump’s victory, they will hold on to this idea regardless of what other sources or information may suggest.

This is, again, because the analysis of fundamentals in crypto markets is very challenging. Unlike traditional stocks, which can be evaluated based on factors such as earnings reports and revenue growth, cryptocurrencies often lack similar financial metrics. Hence, crypto investors are particularly susceptible to believing in discussions in the media and various online forums.

There have been no details on how Trump’s promise^[21] to make the US the Bitcoin superpower of the world will be delivered. However, it would be hard for crypto investors to change their minds if they are already anchored to this idea.

Investing is not gambling. Even if you think your decision is entirely rational, it is essential to triple check to ensure you are not subject to any of the aforementioned behavioural biases. You’ll probably be subject to all of them, as will any other human being.

Read more https://theconversation.com/crypto-gains-momentum-as-markets-eye-trump-election-four-things-to-consider-before-you-invest-241731

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