Recent weeks have seen massive sell-offs in the cryptocurrency space, which naturally has led many would-be investors to question whether to enter the crypto market, as well as causing others to sell their own holdings out of fear of further losses.
In reality, while such market declines can certainly seem alarming, they aren’t anything new for the crypto market, which has seen many significant increases and decreases in value over the last several years. Investors who understand market psychology basics — particularly, how to stay rational during market declines such as these — will position themselves for much better long-term outcomes.
The Dangers of Emotional Responses In Investing
Regardless of whether you are investing in traditional stocks or learning how to invest in cryptocurrency, one of the first lessons that experienced investors teach is that individuals should avoid emotional responses. When investors let emotions cloud their decision-making, they tend to make less reliable choices than they would if they took a step back to think rationally.
Despite this, many investors in crypto and other spaces let emotions take over during major market declines or other headline-grabbing events. Southern New Hampshire University cites fear and greed, herd mentality (or following the crowd), overconfidence bias that leads to excess risk taking during market booms, and loss aversion as some of the top psychological factors that drive irrational behavior and poor market choices.
Allowing your view of the crypto market to be influenced by these psychological factors may seem like the best choice in the short term, but this typically leads to negative long-term consequences. In fact, one study found that 69.2% of high-income male investors regretted their emotional investing decisions.
Cryptocurrency’s historic volatility in comparison to other investment options makes the potential for these emotional responses, and the associated negative outcomes, even more likely.
Cryptocurrency Investments Also Favor a Long-Term Approach
Even though cryptocurrency tends to be more volatile than other types of investments, many of the same market psychology rules still apply. First and foremost is the value of looking at cryptocurrency as a long-term investment.
Long-term investing is generally considered a more emotionally stable approach because it results in a more passive approach to investments. Rather than tracking every up and down in the market, investors instead focus on making consistent contributions so they can reach a long-term goal.
Analysis of holding stocks for the long term has found that a long-term approach makes it easier for investors to ride out temporary market downswings, with long-term investments typically outperforming short-term trades made in an attempt to time the market.
This also helps investors avoid one of the most common risks of emotional investing — selling as a cryptocurrency starts to lose value, but then not jumping back in as a rebound starts. Instead, they wait to jump back in until most gains have occurred, causing them to miss out on the growth that comes with the rebound.
Despite the relative “newness” of cryptocurrency investing, the value of a long-term approach still holds sway. “Hold on for dear life” (HODL) has become a noted cryptocurrency investing strategy that has allowed many crypto investors to ride out previous market declines and experience significant gains after the crypto market recovered. Beyond helping investors avoid fear of missing out (FOMO) or other emotions that lead to attempts to time the crypto market, many crypto investors believe this approach prepares them for a time when crypto will become more important than government-issued currency.
The Importance of a Clear Plan
Even with a long-term mindset, major crypto market declines can cause some investors to begin to second-guess their choices. While having a general long-term (or even HODL) mindset is an important start, you can also improve your ability to stay rational by implementing a structured plan for how you trade crypto.
For example, rather than trying to time your investments in crypto, you could join the 59% of crypto traders who use dollar cost averaging as their primary strategy for crypto investing. Dollar cost averaging sees traders invest at consistent intervals (such as monthly or weekly investments), rather than focusing on specific crypto market ups and downs. Automated trading tools can take this process out of your hands entirely so that trades occur based on your chosen timeline, without the need for any extra input.
You can also support your crypto investing strategy by conducting a technical analysis that helps you set predefined stop-loss trade orders or take-profit targets. Rather than making buying or selling decisions during times when your emotions could take over, setting such guidelines in advance will essentially automate the decision-making process.
Each of these guidelines should follow your overall investing goals, which will consider your general risk tolerance, as well as how diversifying with multiple forms of cryptocurrency or other assets plays a role in your strategy.
You Can Stay Rational
While recent crypto market declines are certainly concerning, they don’t diminish the importance of taking a long-term approach with crypto investments, just like one would with traditional stocks or mutual funds.
By developing a clear trading plan and taking steps to remove the emotional element from investing decisions, you can avoid making emotional responses that hurt your potential for maximizing future returns.
