By Larry Wright
Introduction
Cryptocurrencies are inherently more volatile than commodities and stocks. Therefore, investors need to have razor-sharp sense and extensive knowledge of the market at their disposal to make the best trading decisions.
By learning about prevalent trading practices, investors can increase their skills and gain more experience in the crypto trading dynamics. In this article, the reader is going to learn about a particular trading strategy known as Greater Fool Theory and get a chance to compare it with its contemporary methods.
What is Greater Fool Theory?
Greater Fool Theory is the idea that investors depend on appreciating prices and trading volume of a given asset based on other traders. In practice, it is about counting on the natural phenomenon that other investors are going to buy in the same asset for a higher price and will continue to fair higher regardless of its fundamental vitals.
Therefore, investors feel at ease in acquiring the asset that garners such a position in the markets that others will not hesitate to buy it from them at a higher price.
That someone else is marked down as a greater fool. This type of trading technique bases its decisions and evaluation on the psychology of the investors. Therefore, investors usually don’t feel a lot of emphasis on technical aspects such as analytical indicators and fundamentals.
The main aim of the investor is to locate a cryptocurrency with high demand and a strong positive presence in the market. In doing so, the investors automatically warrant a solid trading position and can ensure closing their positions at a profit.
The Basic Elements of Greater Fool Theory
To understand how Greater Fool Theory has become a certified and recognized trading practice, investors must take a deep dive into its foundational components. Some of the forces and factors at work that gives weight to the Greater Fool Theory are listed as under:
Crowd Psychology
Crowd Psychology is a phenomenon that reflects the collective bias of a human group. It is rooted in the primal need of human beings to dwell in groups for the sake of safety, innovation, and prosperity. When the early humans started to cultivate the land, they needed to stick around more and had to give up their nomadic lifestyle. Easy and predictable access to food from agriculture allowed humans to grow in numbers and dwell in colonies.
As per the description of author Yuval Noah Harrari, in his book Sapiens, the reason for human evolution is their ability to create fictional concepts such as deities and public limited companies. Human history is the root that explains psychological observations like a herd mentality.
Crowd psychology is the product of the same biological need in human beings. In the same manner, investors fall prey to market hype and Fear of missing out or FOMO. These inclinations can make a considerable impact on the performance of any asset.
Therefore, smart investors can keep an eye on the collective perception of a market and make the best trading decisions by following the intrinsic trait of human nature.
Market Speculation
Market Speculation is such a strong force that it can envelop just about the most cautious and prudent investor in its colorful deception. Researchers have shown the deep-seated impact of marketing and external grooming on the human mind. Alex Boese mentions in his book Elephants on Acid, such a case study.
Psychologists found out that people felt the taste of a cold drink differently based on the brand labels. Even in cases where the test subjects were sipping the same drinks, they described that both drinks tasted different due to the impact of marketing and popular opinions in their circle.
In the same manner, any cryptocurrency investor can develop a positivity bias towards a particular cryptocurrency without realizing it. People tend to hold on to their biased and unqualified opinions when they face antagonism.
Therefore, Greater Fool Theory takes all of these factors into account and allows investors to take advantage of these natural conjunctures to get the most out of their trading experiences.
Profit Potential
At first glance, the idea of depending on other investors can seem like something that a child comes up with. However, Greater Fool Theory is a recognized and formal trading strategy that all professional investors are aware of.
Since this theory can increase the probability of increasing profit percentages significantly, therefore it has been treated as a bonafide trading tactic. Cryptocurrency investors who wish to grasp the market mentality and hone their trading skills can also benefit from it.
Social Influence
Social influence is a strong force acting on the human mind that has been ingrained in human psychology since childhood. A series of experiments have shown that people tend to feel more comfortable sticking to wrong conclusions if it allows them to remain part of a group. This psychological occurrence is called Conformity Bias.
Cryptocurrency investors are also not free from it. In the age of social media, the Conformity bias has breeding grounds even more potent than before. Most cryptocurrency investors are likely to seek companionship and support in the form of online forums.
Therefore, they are likely to adhere to the ideas and sentimentalities that are prevailing in their native group rather than being a sore thumb and making their trading decisions independently. This is another strong case for the reason why Greater Fool Theory works.
Precaution
According to psychologists, the brightest minds can’t exclude themselves from all psychological biases. However, a person who is aware of these biases is in a better position to make better trading decisions in comparison to those who are completely unaware of it.
Therefore, it is another important reason that aspiring cryptocurrency investors invest their time in learning about forces like Greater Fool Theory. In this manner, they will work towards developing a better mental defense against it and use it to their advantage instead.
Bubbles and Scams
Most people do not realize the power of Crowd psychology on the human mind. Take, for example, diamond rings. Until a Diamond Cartel, DeBeers started to market the idea that people should purchase diamond rings as an engagement proposal; it was never the norm.
Eventually, the idea that men should invest at least a 2-month salary on a shiny rock that does not even have a good enough resale value was adopted by Crowd Mentality.
There are some major financial scams and bubbles that are the result of the same herd mindset, such as the Dutch Tulip mania, the Housing Market Crash of 2008, and the dot com bubble are some of its visible examples.
Under these circumstances, Greater Fool Theory is a practical tool that introduces investors to this important market factor and allows them to recognize scams or bubbles from a distance.
Origin of Greater Fool Theory
According to some sources, the Greater Fool Theory was invented by American Economist Burton Malkiel. He is known for his publication A Random Walk down Wall Street, and he has experience working with financial giants such as Vanguard Capital.
He is considered an expert authority on closed-end funds and also served as the Chief Investment Officer of Wealthfront. He has been attached to Princeton Economics Department and has been attributed as the person to quantify the GrFT.
Since the Greater Fool Theory has such qualified origins, it is natural that noteworthy financial enterprises such as Harvard Funds, Investopedia, CoinMarketCap, Motley Fool, Big Think, and many others acknowledge and use it in their trading tools arsenal.
What are Some Important Crypto Trading Strategies?
While reading this article, the investors must have realized the importance of knowing a simple trading strategy that can make a big difference. Therefore, for the benefit of the crypto users, here are some of the most important cryptocurrency trading strategies that they can benefit from:
Day Trading
Day Trading is a trading strategy based on the duration of a cryptocurrency position. As visible from its name, Day Traders aim to create and dissolve new trading positions within 24 hours. This trading style has many benefits since Day traders base their trading decisions on technical and fundamental analysis alone.
Furthermore, Day Traders aspire to remove any market emotions or biases from the market, and they try to take advantage of the high volatility and liquidity of assets such as cryptocurrencies.
Therefore, Day Traders can remain secure from prolonged trading stress, and they are at liberty to take advantage of as many new positions as time and money allow them. Day Traders can also increase their profit percentage through Leveraged Trading.
Martingale Trading Theory
Martingale Trading strategy is an idea where the investors aim to double their asset accumulation when they suffer from losses. This type of trading takes its reference from the principles of probability and laws like the Monty Hall Paradox.
There are also parallels to this trading theory, such as the anti-Martingale Theory, which is the exact opposite of its reflections. When using the Anti-Martingale Theory, investors are taught to cut down their cryptocurrency reserves by half every time they suffer from losses.
Depending on different market dynamics and asset nature, investors can take advantage of both these trading systems.
Range Trading
Range Trading is the idea that traders can make impactful trading decisions by focusing on important price ranges for an asset. In this type of trading, investors look at the critical ranges such as support and resistance.
Support is a level where a cryptocurrency is bound to stay rather than crash further, while resistance is the maximum possible output of a cryptocurrency. By paying attention to the price movements of cryptocurrencies between support and resistance, investors can get the best results from the market and increase their chances of generating profits.
Arbitrage
Arbitrage is one of the oldest trading methods that date back thousands of years back the primitive humans. Arbitrage removes the need for using intermediaries such as fiat currencies or payment cryptocurrencies to fulfill the role of medium of exchange. The DeFi ecosystem has reinvented itself by introducing entities like swaps.
With decentralized swaps, investors can exchange cryptocurrencies based on their proposed contracts. There are also cryptocurrency exchanges like FTX that have popularized the idea of Arbitrage Trading once again.
Scalping
Scalping is a trading method where investors tend to scrap the smallest possible profit margins from the market. However, they can make a big buck by increasing the frequency of their trading positions.
Scalping is essentially a short to medium-term trading strategy. In most cases, investors use leverage positions to increase their capital size and place bigger bets. Scalpers also take advantage of assets like cryptocurrencies that have high volatility and liquidity.
Primary Research
Primary Research for cryptocurrency trading is the stepping stone for aspiring cryptocurrency investors. To this end, cryptocurrency investors tend to gather all the possible information from available resources regarding a cryptocurrency.
Interestingly, with primary research, investors also tend to gather all the news and latest developments about a cryptocurrency before investing in it.
They are opting to make an effort to learn about the developers, reviews, stability, authenticity, road map, technical audits, scams, hack attempts, and other important factors to ensure that they are not falling into a financial trap.
High-Frequency Trading
HFT is a very advanced and dexterous method of trading. In this method, investors with programming knowledge can set up AI bots or machine learning algorithms to conduct trades in bulk. The software for trading can have the ability to learn from experience, or it can be a simple command-based entity.
Some investors can purchase these trading bots. However, trading bots carry considerable risks. They require a considerable amount of knowledge and skill to operate or generate. Therefore, this trading method is reserved for advanced traders with extensive knowledge of the financial, mathematical, and cryptocurrency markets.
Balanced Portfolio
Cryptocurrency traders who have a basic idea of the market but they still lack some insight can use techniques like a balanced portfolio. Building a balanced portfolio is all about getting all about following the useful advice from successful traders like Warren Buffet to never put all your eggs in one basket.
It means that investors should fashion their trading portfolio after a market index or mutual funds. In this manner, they can add a host of different cryptocurrencies, such as Bitcoin, Ethereum, Dogecoin, Shiba Inu tokens, etc., to increase their chances of making profits.
Furthermore, investors are motivated to keep a fixed ratio of every unique cryptocurrency in their portfolios to get the best chance of beating volatility.
Dollar-Cost Averaging
Dollar-Cost Averaging is a type of trading technique where the investors refrain from pouring all their trading capital into a cryptocurrency at once. Instead, they choose to increase their cryptocurrency portfolio after regular time intervals.
The investors can decide on different market factors such as price movement, trading volume, or changes in fundamentals to add the next increment to their trading positions. At the same time, the investors also divide their investment capital into different portions to use at their discretion. DCA is a long-term trading method.
Derivatives
There is a way of making profits from cryptocurrencies without ever buying a single crypto coin or token. This way is called working with derivatives. Investors can place bets based on the expected price movement of a cryptocurrency in a financial contract.
These financial contracts are called derivatives, and there are several types of cryptocurrency derivatives, such as forward contracts, Options, futures, swaps, and others. However, it is important to note that derivatives are riskier, and they generate smaller profits than directly owning a cryptocurrency.
Turtle Trading
Turtle Trading is a quantified and stringent trading system that enables investors to purchase new cryptocurrencies during a breakout and sell them during a retracement. Turtle Trading is also a long-term trading strategy.
Investors who are participating in this method need to adhere to their predetermined trading plan regardless of any short-term variables. Turtle trading system has been known to create better results than some of the top stock market indices such as the S&P 500 and Dow Jones.
Hedging Strategies
Hedging Strategies is a trading method where investors are looking to isolate crypto trading pairs that have inverse trading fundamentals. In most cases, investors are looking to increase their trading profits by jumping into a particular category of cryptocurrencies, such as blockchains with Layer 2 solutions or stablecoins.
However, with Hedging strategies, investors can hold deflective cryptocurrencies. The idea is that when one cryptocurrency is going down, the other will rise due to their inverse proportional relationship.
Conclusion
Greater Fool Theory is a useful trading strategy that can help investors gain a new perspective on the governing forces of the cryptocurrency market.
At the same time, investors must also look into the host of other cryptocurrency trading strategies to make sure that they are getting all the information needed to deal with any market situation and formulate the perfect personalized trading strategy with cryptocurrencies.