When an asset enters a bear phase and the headlines are negative, analysts project further downside, and the sentiment shifts from optimism to pure gloom and doom. This results in panic gripped traders dumping their positions near the bottom of the downtrend instead of buying.
How can traders go against the herd and build the courage to buy in a bear market? It is not easy because if they purchase too early, the position may quickly turn into a loss. However, if they wait for too long, they may miss the early part of the rally.
Although pulling the trigger during a bear phase is difficult, the relative strength index (RSI) indicator can identify market bottoms and favorable risk to reward scenarios.
Let’s review a few examples of when to buy in a bear market.
Look for extremely oversold levels on the RSI
Bitcoin (BTC) topped out close to $ 20,000 in December 2017 and started a long gut-wrenching bear market that bottomed out near $ 3,300 in December 2018. During this period, the RSI entered the oversold territory (a reading below 30) on five occasions (marked as ellipses on the chart).
In the first four instances, the RSI dipped close to or just below the 30 level but during the fifth time, the RSI dropped to 10.50. This is a sign of capitulation where traders who had been buying pre-empting a bottom or had held their positions in the bear market succumbed to fear and purged their holdings.
Usually, long bear markets end after prolonged periods of fear-based selling. Smart traders wait for these opportunities and buy when the markets are deeply oversold, like when the RSI below 20.
Fast forward to 2019 and 2020 when the RSI dipped close to 20 on two occasions and dropped to 15.04 on March 12, 2020.
The first instance when the pair dropped to 19.60 on Sep. 26, 2019, turned out to be a losing trade because the price made a new local low weeks later on Oct. 23, 2019. This shows that traders should be ready to close their positions when the stops hit because if they don’t do that, the losses may keep growing.
On Nov. 24, 2019, the RSI dropped to 22.32, just above the 20 level. For traders who keep a very tight stop, this would have also turned out to be a losing trade with the drop on Dec. 18, 2019. However, these were all small losses, which would not make a dent to the portfolio unless traders were using heavy leverage.
The RSI plunged to 15.04 on March 12, 2020, and traders who were brave enough to buy after this drop would have made outsized gains had they held onto their positions during the bull phase, which topped out at $ 64,854 on April 14, 2021. This shows how after two losing purchases, traders eventually hit the jackpot using the RSI signal.
Author: Cointelegraph By Rakesh Upadhyay
This post originally appeared on Cointelegraph.com News