Narrative Trading in Crypto

Trading narratives can create big opportunities for crypto traders looking to capitalize on emerging trends and technologies. However, these trends tend to be short-lived & carry high risks. It is thus important to approach them cautiously and always do deep research before making any decisions.

The success of any narrative depends on a complex array of factors, including technological feasibility, market demand, and broader cultural trends. There is no guarantee that a particular story will play out as expected. In this article, we’ll walk you through the concept of narrative trading.

Read our article that explains what a crypto narrative really is here.

Narratives in bull and bear markets

Opinions are divided as to when narratives have their strongest impacts on the market. While some believe it is during the manias of a bull market, others believe it is during the depths of bear markets. Objectively speaking though, they tend to work in any market condition.

Intuitively, one would assume that it's much harder to promote narratives in a downtrend, but they would discount the desperation of traders that are hoping to make some money back. Likewise, during bull markets, the overwhelming majority is busy chasing higher highs in blue chips & can ignore the silent narratives.

Regardless of the market cycle, being prepared for incoming narratives will always position a trader ahead of those that are blissfully unaware. Even if we do not believe in them, money can be made by anticipating and trading the trend.

While some argue that crypto needs to focus on real-world use cases or fundamentals rather than narratives, the fact remains that narratives have a gravitational effect on market sentiment. So let's get ahead of the game by understanding what narrative trading is and how it works.

Narrative Trading 101

While at first glance narrative trading may seem like a purely speculative and risky strategy, it is important to note that throughout all of history, narratives have been the foundation upon which financial markets have been built. Market participants have long relied on stories to make sense of complex financial information and find meaning in often chaotic environments.

As is the case with any other strategy, narrative trading can be seen as a double-edged sword. On the one hand, it can create a sense of excitement and optimism around new technologies/concepts, which can attract investment and spur innovation. On the other hand, it can lead to vaporware and speculative bubbles when the story fails to materialize. Market sentiment shifts and investors lose money, confidence in the narrative or even the market as a whole.

Let’s take a look at two prominent examples, both outside of the crypto-verse and one inside, Tesla & Bitconnect.

The effective narrative: Green Energy

Tesla was built on the promise of one day delivering the world’s first mass-market all-electric vehicle. With nothing more than a few sketches & failed models the company managed to pull in $7.5 million dollars of funding in 2003 ($6.5 million of which came from Elon Musk).

After five long years and a multitude of failures, it released the first Roadster. Unable to produce the car en masse, the vivacious CEO kept pushing his vision and expanding the promise of a green future.

Fast forward 15 years and the company is still yet to achieve its goals. Nevertheless, the story around it has captured the public’s imagination and kept millions of people talking about its future. Whether or not Tesla will be the company that provides the world with the most common electric vehicle is unknown, regardless of that, it has grown from its humble beginnings of ~$2 billion in market cap to a glorious 500+ billion-dollar company despite not being profitable until 2022.

The toxic narrative: HYIP (High Yield Investment Program)

Bitconnect was a crypto project formed in 2016 that rode on the hype of open-source decentralized digital money. Prying on the hopes of those that “missed Bitcoin”, Bitconnect promised to enrich people's lives by allowing them to get in early on an innovative HYIP and lending protocol while having its own token (BCC) appreciating in value.

Over the course of ~2 years, the project attracted millions of people and billions of dollars. Everything seemed too good to be true, but it was working fine, until that fateful day.

On January 16, 2018, Bitconnect announced that it was shutting down operations after the American government issued a cease and desist order. Within a few short days, the BCC token wiped out tens of billions of dollars of market capitalization and defrauded >$2 billion dollars from investor “deposits”.

Bad actors and narratives

Because of historic events such as the one described above and the fully open, anonymous and global nature of the industry, the term "narrative" has grown to get a bad reputation among many industry participants.

While associated with the idea of a compelling story that drives attention and attracts buyers to a particular coin, protocol, or product, many bad actors have taken advantage of the untrained trader's greed by spreading false narratives. These false narratives significantly impact a trader's psychological predispositions and skew their decision-making capabilities; especially during those heated moments of bullish sentiment. Hence, always be cautious about any narrative and its sources.

Trading the Crypto Narrative

Crypto is an ultra-sensitive industry that moves at the speed of information. A regulator can wipe $100 Billion dollars off the market cap as easily as a tweet from a celebrity can spark a >100%+ rally.

As portrayed in the examples above, narratives can last a lifetime or disappear overnight. They can be used to build an industry, or rob people blind. They depend equally on predictable internal factors as much as they do on unexpected external ones. What may seem like a good story one day, can turn out to be a cautionary tale the next.

The successful application of a narrative trading strategy in crypto largely depends on two factors; timing and principles.

In regards to timing, a trader must be able to have a good sense of valid emerging trends and concepts before they become widely accepted by the market. They must be able to distinguish between empty promises and probable reality; a form of thinking that is rooted in fundamental first principles.

In addition to the mental acuity, traders must formulate a well-defined set of principles to abide by; a concrete set of rules that will offload cognitive biases and automate their decision-making. The most successful traders all have one thing in common, a huge emphasis on risk management. A well-designed exit plan will minimize any potential losses in the case of a narrative failing to gain traction, as well as help lock in gains. As the legendary American financier, Bernard Baruch said “Nobody ever lost money by taking profits”.

Let’s gloss over some of the more recent narratives that have shaken up the crypto industry:

Right after Facebook announced that it will be rebranding to Meta, a huge wave of hype around the metaverse flooded crypto. In the span of a month, projects like Sandbox and Decentraland saw eye-watering capital inflows rocketing their token values by over 1000%. One year later the tokens are trading below their pre-hype prices.

ChatGPT opened up the pandora’s box of AI. Prophecies of singularity and the rise of a new workforce flushed over the crypto markets. Every project with Artificial Intelligence in its name/roadmap skipped the rocketships & went straight to the moon. We have yet to see how this will pan out, but as history shows:

“we tend to overestimate the effects of a technology in the short run and underestimate in the long run” - Amara’s Law

The power and perils of narrative trading

Narrative trading in crypto is a research-intensive process demanding an understanding of how major or macro events might be connected to crypto and which coins might benefit from them. The goal to foresee what story the world will want to hear is no simple task. It is a multifaceted discipline that requires deep, critical thinking and strong analytical skills. Traders must be willing to put in the hard work required to stay ahead of the curve.

However, it's important to remember that narrative trading is not the same as investing. Traders need to have an exit plan in place since every narrative will eventually cool off, and the tokens will retrace. Additionally, it's crucial to be faster than everyone else by working harder than everyone else since new narratives can form very quickly. It takes just a few similar projects to show significant gains for the masses to appear.

Crypto is still the wild west of finance, and traders need to be prepared for various outcomes and be willing to take on high risk if they hope to achieve high returns.