Bitcoin just crashed. Is there more pain to come?

Myles Dunphy
December 8, 2021

Well, I wasn’t expecting that. Bitcoin flash crashed yesterday from around $54,000 all the way down to $42,000.

So what is coming next, and what should we do about it? In this blog post, I’ll break down my 4 step thought process when sudden market moves like this occur.

  1. Trade direction - Buy, sell, or wait? 
  2. Allocation - How much to buy or sell? 
  3. Timing - When to act?
  4. Execution - How I’m placing my buy or sell orders.

1. Trade direction: Buy, sell, or wait?

The first question is, is this the time to buy, sell, or hold? The way that I am going to think about this is using fundamental analysis. Looking at bitcoin in the longterm, it's a secular bull market that just goes up. It has a lot of volatility in the short term but in the long-term, it just goes up and I believe that it’s going to continue to go up.

But has something fundamentally changed in today’s market and in the last two days before the huge crash happened? Is the long-term bull market now over or is this just another liquidation event? Is it just another one of those crashes that has happened back in 2018 and 2020?

To me, some things that would break the long-term bull market (my long-term thesis) would be something like a war. Literally, if something in the economy has had a massive change overnight then that would be something that will make me rethink my positions in crypto.

Another thing is if a real protocol hack happened. If someone actually reported and confirmed that there are ways to print Bitcoin instead of it having a fixed supply. This scenario would bring Bitcoin’s price to zero which means I need to get out and sell as soon as possible, if I still have a chance to get out.

In this specific crash, nothing appears to have changed. It looks like a liquidation event; when you add sudden leverage into markets like these, a lot of participants are making bets in the short-term using leverage to fuel their potential returns but they also end up taking larger risks. As you can imagine, if you have hundreds or thousands of people getting liquidated at the same time, that’s what causes the huge drops.

So anyway, this is just a liquidation event. Overall, zooming out to the yearly view or the monthly view, it appears that the bull run is still very much in progress. Knowing that the long-term thesis is still in play, I still believe that that long-term structure is going up.

2. Allocation: How much to buy or sell?

The next question is how much should I move my position, if I need to move it at all? This is a very personal thing. Specifically, in my case I have a certain percentage of allocation in my portfolio that I want to be in crypto. What that does for me personally is it allows me to take a lot of the emotions out of these movements. 

For example, if I’ve got x% of my portfolio in crypto and the price of crypto doubles, that percentage allocation is probably going to double as well. When this happens, what I’m going to do is sell some of my crypto to bring it down so that it ends up staying around x% of my portfolio. Vice versa, if the prices are dropping then the allocation is dropping as well. In that case, I would actually want to buy to bring the allocation back up to x%.

Right now, my cash allocation is higher than it should be, and after the recent drop, my crypto allocation is lower than it should be. So I want to sell cash and buy crypto to balance it out. That is my personal strategy for how I’d be allocating in this case.

3. Timing: When to act?

Just a little disclaimer, I am not a trader and I am not an expert in technical analysis and I like to keep things simple. I like to make things as simple as possible so that I can make decisions easily and just walk away and come back later if something changes.

Here I want to know whether I should buy now, or wait. 

In this case, without being too complicated. What historical data can we use? The way that I’d like to think about this is that “History doesn't repeat but it does rhyme.” Patterns tend to re-occur, and when we have market data like this, it can be useful to look back to past events to use as guidelines or boundaries for what’s reasonably possible to occur again today.

So, I’m going to look back and review similar crashes that happened in the past. I want to know — is this event that just occurred yesterday more like the crash that occurred in May 2021, March 2020, or November 2018?

Basically, I’m trying to identify the Zone of Max Pain. That’s the best time to buy; when it feels the most scary, painful, and fearful. Historically, that is when you get the cheapest prices.

May 2021 Crash

Duration of Max Pain: 2 months

Here we had an extended Max Pain zone; it took a while for the market to realize that we were actually going down into this Max Pain. Finally when we got there, we could bounce up and start the next phase. 

March 2020 Crash

Duration of Max Pain: 10 days

This was a huge, quick liquidation event. The Zone of Max Pain only lasted about 10 days;  a really small zone where you had the best prices while everybody was scared and fearful.

November 2018 Crash

Duration of Max Pain: 5 months

This was the bear market crash from mid-November 2018 to around early-April 2019. In the past two crashes that I mentioned, the liquidation event was essentially the zone of Max Pain. But in November 2018, the liquidation event was not the bottom. It actually took another month to reach that zone of Max Pain from that cascading liquidation event that happened at the start. And then it took another six months to drag the market out of it.

Using the Relative Strength Index (RSI)

One way to compare these three events is through the RSI (Relative Strength Index). A really high RSI means that the price action may be too exuberant and likely to cool back down. On the contrary, a very low RSI may indicate you’re entering into a time where price has been suppressed and is more likely to bounce back up. 

Right now we are at 32 RSI which means it’s oversold. However, if we look at the RSI of the Max Pain back in May 2021, we were at 23. If we look back at March 2020, the RSI went down all the way to 15. In 2018, RSI went even further down to 10. 

What this indicates is that potentially, if it’s like these last events, the RSI could go even lower, meaning that prices could continue to slide down further. 

Using the Fear And Greed Index

In the Fear and Greed Index, Extreme Fear can be a sign that investors are too worried and this could be a buying opportunity. On the other hand, when the investors are getting too greedy, that means that the market is due for a correction.

The Fear and Greed Index for the event now is at 18 which is pretty low. That’s extreme fear. However, if you look back at the past events, the FGI is 10 in May 2021, 8 in 2020, and 12 in 2018. This shows that we were even more fearful back then.

So we have three different potentially repeating scenarios.

  • In the first, we have a really quick pure liquidation event. Everyone on the wrong side gets liquidated and we bounce immediately back up.
  • In the second, we have a similar correction like May 2021, where it took the market around 49 days to bounce back up.
  • In the third, we have a repeat of the 2018 bear market where it took almost almost 5 months to start coming back up. 

What I am trying to work out now is if this price is the lowest it’s going to go. Do I think it’s going to get much lower and take much longer or is it like a potential real bear market?

Obviously, your actions are going to be different in each scenario mentioned above. All I can do is to weigh the balance of probabilities.

The question is, should I just buy now at $49K? Or is the event going to be more like in May where we could have a couple more months to buy and it could go back down to $40K? Or are we going to a really bearish case where we could have another drop of around 25%?

Three potential outcomes (based on May 21, Mar 20, Nov 2018 liquidation events)

In this case, if I am looking at this in a really bearish case, it’s probably going to take us back down to the $30K level again. I don’t want this scenario to happen because it would really suck — and I also don’t think that it is a very likely outcome. Yes, it could happen but I am not going to bet on it.

Instead, I think the event that has just occurred is more likely to be some combination of the March 2020 rapid liquidation event where we bounced quickly back up, and the May 2021 event where the zone of Max Pain is significantly more drawn out and we had more opportunities to buy back at low prices. 

4. Execution: How I’m placing my buy/sell orders.

Okay, so I am not going to sell. That much is clear — but how am I actually planning to buy into this?

To me, it’s not clear exactly what is going to play out. It could easily drop back down to the bottom this week which could be around the $42K level, or it could not. Here, I want to hedge my bets and allow for this uncertainty. When I am looking at buy orders, I’m trying to balance stress vs getting a good price

Note: I am not trying to get the best price. While it would be very lovely to be able to buy at the very bottom of the zone of maximum pain all the time, that is not a realistic outcome. Instead, I’ll be happy with access to good discounted prices when everybody else is fearful. 

I am also trying to balance out stress. I want to just be able to set the strategy in motion and just walk away because I have got other things to do... I have a life to live! So, I want to find that happy balance.

The way that I am going to do this now is to set a series of buy orders. I personally prefer to set a range of limit orders based on where I think the price could go in the near future. If I get my orders filled and the price keeps dropping, it's okay because I'm not stressing about getting the exact best price. Also, if the price goes up and my orders don't get filled, it's also okay — I'm not stressed, and as the price goes up, the percentage of my crypto allocation goes up which evens out the imbalance anyway, so I'm still happy.

So in this scenario, I am going to buy at the current price so that I feel good if the price starts to go up again because I was able to buy. But, I am not going to buy all of my allocation at this price.

Instead, I am going to do a laddering DCA in price. This means that I am going to set limit orders at: 

  • $49K (current price); 
  • $47K;
  • $45k; all the way down to the liquidation wick price of $42k.

To me, this is my balance of stress and getting a good price.

What am I actually buying?

I am not just buying Bitcoin, although I do hold a large portion of my portfolio in Bitcoin because it’s less volatile compared to other coins.

What I found interesting about the recent crash is that generally, with these liquidations events that happened previously where everything drops really quickly, they are all interconnected. That was the March 2020 crash, it was an interconnected financial liquidation event where people were trying to sell whatever they could so they could not get completely wiped out of everything.

In the crypto market, when Bitcoin drops, everything gets dragged down with it. In this case, it happened and Ethereum actually dropped by around 20% but that is less than what Bitcoin dropped down and it is also still up in the last seven days.

This relative outperformance of Ethereum and some other Alts is making it look like Ethereum is starting to just display more and more strength against Bitcoin.

So, I will be buying approximately 50% BTC and 50% ETH, both set with laddering limit orders as described above.