What is a Crypto Market Correction?

A crypto market correction is a temporary dip in crypto prices when the multi-year main uptrend has not yet been invalidated. In other words, it is simply a shorter-term cooling down of prices from over-zealous traders that caused an overheated market condition. As such, a cryptocurrency correction is much less severe than a market crash. Given the volatility of cryptocurrencies, such market corrections are common and should not be feared. Instead, when investors know how to turn such short-term drops to their advantage, they can often improve their return on investments dramatically by efficiently trading, averaging, or even hedging their positions during these periods.

Understanding Market Cycles

Before we dwell deeper into the mechanics of a market correction and how to trade one, we need to understand what a market cycle is. A typical market cycle consists of a bull and a bear season. In a bullish season, prices are generally fast to rise, and investors find it easy to earn profits when they buy, while in a bearish season, traders typically lose money on their long positions if they are unprepared.

Historically, a crypto peak to trough market cycle lasts for about 4 years, with frequent price corrections in between.

What is a Crypto Market Correction?

While there is no pre-set boundary to define a market correction, most experts agree that a correction should have a decline in the market of between 10%-20% from its peak prices.

What Is the Difference Between Crypto Corrections and Other Market Events?

Due to the more volatile and fast-moving nature of cryptocurrencies, crypto market corrections can happen and recover within days or weeks, especially amid a bull market where traders are aggressively buying up any dip in anticipation of prices to rebound swiftly. Corrections also happen much more frequently in the crypto market as compared with the stock market or the fixed-income bond market, where such corrections happen less often, and prices generally do not rebound as fast as cryptocurrencies.

Crypto Market Correction vs The Dip

A dip has an even shorter duration than a market correction and the depth of the decline of the overall market is also shallower, usually only between 5%-10%. While a crypto market correction often lasts several days, a dip usually is over and done with in a matter of hours or up to a couple of days at the most.

That said however, continuous small daily dips should not be ruled out and these occurrences may eventually end up becoming a correction if these declines add up to 10% or more in the total market over several days.

Crypto Market Correction vs Bear Market

While a dip is a decline in prices of less than 10% and a market correction is a price retreat of less than 20%, a crypto bear market is typified by a broad market decline of 20% or more, affecting overall market sentiment. A bear market is believed to have gotten its name from the way a bear attacks its prey by continuously swiping its paws downward. Hence, a bear market is synonymous with a longer-term, more sustained period of market decline that takes place over a longer duration, ranging between months to years.

Crypto Market Correction vs Crypto Market Crash

A crypto market crash, as you would have been able to guess by now, is a large and sharp decline in crypto prices that occurs within a short duration. Market crashes are often triggered by sudden unanticipated market events that catch everyone by surprise, impacting overall market sentiment. A crash can happen overnight, or over a few days, and depending on the factors that caused the crash, may take several weeks or months to recover as investors need time to digest the event and find confidence to return to the market. For instance, the March 2020 Covid-led selloff was an example of a market crash.

What Happens During a Market Correction

The most obvious result of a market correction is a broad-based fall in asset prices. Asset prices adjust downwards when investors either feel that the asset is over-valued, or that they have made very good returns over a short period of time and feel that the rise in price is not sustainable. These market players then sell all or some of their assets to realise their capital gains, resulting in a decline in prices.

Traders who sense a short-term market reversal may even short sell the market to profit from the falling prices.

New investors, seeing that prices are coming off, may put off their decision to buy in the hope of being able to buy at a lower price at a later stage, resulting in a lack of new buyers to support prices, which may cause prices to fall further.

As the magnitude of price decline eases, or when prices stop falling and the market starts to consolidate near a longer-term support level, these buyers who have waited on the side lines are now tempted to buy.

The astute investors who have previously sold may also re-enter the market to buy as prices become attractive to them. With more investors buying, a market rebound occurs as prices start to rise again, and the cycle repeats itself over and over again.

Can you Predict an Upcoming Market Correction?

The short answer is no; market sentiment can shift rapidly, affecting trading decisions. Market corrections are extremely hard to predict, nor are they worth stressing over, since these are mere temporary blips to a main bullish trend. Prices normally rebound back to pre-correction levels or even break higher as the broader trend continues to play out, signaling a recovery in market sentiment.

How long do crypto market corrections last?

Just like there is no pre-set definition, there is also no pre-set limit as to how long a crypto market correction can last. There have been instances where a market correction only lasted a few hours, while most of them lasted between days, or up to a couple of months. Most traders are more concerned about the extend of the market decline than the duration of the decline, as it is almost impossible to predict how long a correction will last. Crypto traders, however, have found ways to identify a bottom where they will be able to capture an early reversal trade to maximize their profits from crypto trading, especially in digital assets like Ethereum.

How to understand that the correction is over

Typically, a correction is over when prices stop falling and consolidate to form a base, indicating a potential recovery. Other times however, corrections can end very swiftly, and prices may rebound very fast. Hence, it is almost impossible for any trader to predict when a correction is over. That said, there are tools traders can use to help them swing the odds in their favour. This method is called technical analysis on the price chart.

Technical analysis is used by traders to spot a market bottom and find high probability trade setups that can earn them the most profits in the shortest possible time. Often, the overlapping of various signals on the technical chart can help a trader spot the end of the downturn and prepare for a recovery.

Some useful bottom picking signals include visual reversal patterns like the bullish engulfing candlestick and the double bottom pattern, or indicator tools like the RSI which signals whether a market is overbought or oversold. When used simultaneously, these indicators are often able to predict a market bottom with good levels of accuracy.

What Triggers the Correction

There can be a myriad of reasons why a market has a correction. The causes of market corrections are exhaustive and oftentimes controversial as not every market expert would agree on a single cause.

Some examples of previous causes of crypto market correction include the Covid pandemic being declared in March 2020, or regulation changes introduced by government such as the mining ban by China in May last year.

Other times, it could simply be that the market got ahead of its fundamentals, or prices have been rising too fast almost in a vertical fashion and needed to cool off. Marco economic factors like an economic slowdown or monetary stimulus being withdrawn can also cause cryptocurrency prices to correct.

A bull rally can only be sustained when there is an increase in the number of buyers. However, as more buyers have already jumped into the market, there will come a time when there are not enough new buyers to keep sustaining the price increase. Once the number of new buyers decreases, or when the number of people selling to take profit increases by more than the number of new buyers, a correction results, reflecting a downturn in market sentiment.

What Should You Do During the Correction Period?

Let us look at what we can do during a market correction to make the best of it and enhance our portfolio.

Strategy 1 – Reduce Risk or Eliminate Market Exposure

This first strategy is based on preparation for a correction. Like we have seen in the above examples, corrections often happen after the RSI hits an overbought territory of above 70. A confluence of top-indicators could usually predict potential market corrections, as analysts often highlight, eg. a shift in market sentiment. when an overbought RSI reading coincides with say, a bearish engulfing pattern or a double top, a trader should consider reducing his long exposure or get out of the market completely and buy back later after price has dropped.

Using the February 2021 correction as an example, one can clearly see that just before BTC corrected, the RSI was at an overbought reading of 80, while at the same time, a bearish engulfing pattern appeared, which subsequently led to a price decline.

Strategy 2 – Dollar Cost Averaging

While the first strategy is preventive in nature, this second technique is a bit more passive, but no less effective, especially for traders who are newer to technical analysis and may not have the confidence to read charts. This is known as dollar-cost-averaging, or DCA in short, which is a very effective and stress-free way to manage a long-term investment. DCA smoothes out the average buying cost of an investment over a long-term horizon, thereby sheltering the investor from the day-to-day volatility which may not affect the price of an asset over a longer time period.

The DCA method involves investing the same amount of funds, commonly referred to as the dollar-cost, into a digital asset at regular intervals, regardless of the price it would be trading at. At times when the asset price is high, the same dollar-cost will buy an investor less units of the asset, while at a time when the price of the asset is low, the same dollar-cost can buy him more units. Thus, when spread over a longer duration, the cost of the entire investment will be at an attractive average price. This strategy works particularly well for cryptocurrency investment like Bitcoin, where the long-term trend of its price is up, reflecting positive market sentiment.

Strategy 3 – Buying the Dip

For the more seasoned investor, he can use technical indicators on the chart to help him identify good areas of entry to capture the next price swing upwards. Generally, longer-term support levels tend to hold up better than shorter-term ones. Therefore, as the market corrects, identifying these longer-term support levels on the chart can give traders a much higher probability of successful trades.

For instance, using ETH in last August’s rebound above as an example, a trader could spot the potential bottom as the RSI fell to the oversold reading of 30, which happened at the same time when a bullish engulfing candlestick pattern occurred. This would be a good opportunity to make a long trade, especially if market sentiment is favorable. As you can see, the price of ETH rallied strongly after that.

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