Every market has cycles. These cycles go through ups and downs and can be analyzed from different perspectives, possibly the most interesting being the binary greed / fear division.

This subjective indicator became famous when Baron de Rothschild said:

“Buy when there's blood in the streets, even if the blood is your own.”

Warrem Buffet also stated something similar:

“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”

Howard Marks, the legendary American investor, has dedicated years of his life to identifying these cycles. His life's work was consolidated in a work highly appreciated in the financial market known as: Mastering The Market Cycle.

According to Marks, When times are good, investors become optimistic and buy financial assets. As a result:

  • Their net worth increases
  • They get access to more credit
  • They feel good about their past decisions
  • They have money (or available credit) to buy more financial assets
  • They buy more financial assets
  • Financial assets increase in price to cope with higher demand
  • Financial assets owned by investors appreciate
  • So does investors’ net worth (hence, access to credit)
  • They have more money to buy more financial assets
  • They buy more financial assets
  • This is how and why financial markets go up.

The problem is when the investors begin taking profits. Throughout history extremely leveraged banks with high exposure to derivatives went bankrupt and generated a cascading effect. This effect, which is becomingo more potent each market cycle, could generate losses on losses, reaching priceless damages not only on the participating players themselves but on the whole society. This huge risk is called a systematic risk.

It was always like that, and I admit that until recently, I thought it always would be. This not-so-distant reality almost happened earlier this year when Archegos, Bill Hwang's family office, wreaked havoc on Wall Street when heavily leveraged bets he made on a small collection of stocks collapsed, causing huge losses in half a dozen banks that they had lent heavily to the investor.

Even though the entire financial system works alternating between periods of greed and fear, there is no reason why someone else's greed will spill over to the society that doesn't have the skin in the game and that certainly would not receive the gains if such operations were successful.

Last week, Bitcoin's price plummeted from around $ 60,000 to almost $ 46,000, liquidating several leveraged positions.

To be more exact, $ 1,744,970,237 of liquidations from short and long positions were settled.

It is speculated that the reason is a possible tax increase for capital gains on cryptocurrencies in the United States. Regardless of the reasons, the consensus among traders is that the liquidation of leveraged positions is good for the market and clear the scenario for us to have new highs.

The big difference, however, is in the fact that there were no government bailouts, there were no setbacks, there were no lawsuits, nor did it take months to see the damage. The contracts were settled instantly, 24 hours a day, 7 days a week. The cryptocurrencies used as collateral changed hands in a subtle way. And the market continued to operate without the need for interventions, each player bearing the consequences of their respective decision. That's exactly how a free market looks like.