How The Stock Market Becomes Indicator For Crypto Market
The stock market has been doing great. Despite the flash crash in March, it’s been generally going up this year. Surprisingly, the overall cryptocurrency trend has been the same. It also crashed in March, then it’s been going up since then. Sure there were a lot of weeks where the two were not really compatible with each other, but generally, the trend looks very similar to each other this year.
It was not always like this. But why has the stock market suddenly become one of the strongest indicators for the crypto market? Let’s analyze it.
2020 Is A Strange Year
2020 has been a strange year. Nobody saw the global pandemic coming. At the beginning of the year, everybody thought the virus would be contained in one city in China. But then it kept spreading to the entire world, and everybody went to lockdown mode. At the beginning of March, both the stock market and the crypto market went through huge sell-offs due to a liquidity crisis that hit both industries. Look at the chart below:
As you can see, the crypto market sell off (as indicated by Bitcoin – candlebar above) was much stronger than the stock market crash (as indicated by DOW index – red line above). However, the point remains the same. Both of them crashed at the same time. Then, when the stock market recovered slowly but surely, the crypto market also recovered slowly but surely.
Since then, both the stock market and crypto market have been closely correlated although not always. It’s a strange year indeed for both markets as they were not like this in the previous year. To compare, let’s take a look at 2019 chart:
As you can see from the late 2019 chart here, the stock market was relatively stable. However, the crypto market kept crashing. And this is not just in late 2019, but also in the previous months prior to that:
From April to June 2019, the stock market was not doing that good, but the crypto market kept going higher. We can easily draw the conclusion here that in 2019 they were not closely correlated, but things changed in 2020 where we have been struggling with a global pandemic.
Most crypto experts and analysts never predicted that the stock market would be closely correlated to the crypto market prior to this year, and rightfully so. However, since the flash crash in March of this year, things immediately changed.
What could be the reason? Well, there are several possible reasons. One of them is the fact that we had a liquidity crisis in early March, so people were afraid of it and decided to stock up on cash. And when both the stock and crypto market had too many people stocking up on cash, both markets crashed.
And since then, the rest was just chain reaction effects. When many traders thought both were moving within the same trend, they formed a certain mindset in their head. They think that it’s a good idea to follow the stock market to predict the next move in the crypto market. It becomes a self-fulfilling prophecy.
Obviously, hindsight is always 20/20, and nobody knows if the stock market will still be correlated with the crypto market in the next 6-12 months. But let’s just say this year, they have been strongly correlated for possible reasons I stated above.
What Happens Next?
What happens in the upcoming quarter of the upcoming year? Will they stay closely correlated forever? We don’t have a crystal ball, so we don’t know. But there are some possible scenarios here with some logical explanations:
First of all, because 2020 has been a pandemic year, I think it’s safer to say that the stock and crypto market might stay closely correlated until we find a vaccine for COVID-19 or until the economy has become stable again. Considering the fact that many businesses all over the world have been struggling a lot with the current pandemic, the stock market and the crypto market might stay correlated for quite some time.
Another scenario that can play out here is if the crypto market’s confidence becomes very high again, like in late 2017. In this case, it’s possible that the crypto market will keep going higher and create a rolling ball effect even though the stock market might remain stagnant (just like in mid-2019 chart above).
Either way, it’s interesting to see that two markets that were not correlated before suddenly become tightly linked since the beginning of this year. You can safely assume that fundamentals that can affect the stock market would probably affect the crypto space as well.