Global markets experienced a tumultuous weekend, with the chaos extending into the trading day on August 5. The DOW and S&P 500 plunged by over 1,000 points, and Bitcoin (BTC) dropped below $49,000. Japan’s Nikkei 225 index suffered its most significant one-day correction since October 1987, while Taiwan’s benchmark stock index saw its worst trading day in 57 years. As almost all markets closed in the red on August 5, traders are left pondering whether it’s time to adopt a contrarian approach and start picking discounted assets.
To shed light on the current volatile market, we spoke with Huf, the founder of Pear Protocol, a decentralized exchange that enables traders to engage in trending narratives through pair trading.
Current Market Misconceptions
Huf believes that market participants are overly optimistic about a Q4 rally, driven by potential catalysts like rate cuts, a smooth transition to a new U.S. government, and crypto-specific factors such as FTX creditor repayments. However, he warns that aggressive rate cuts could lead to sustained downside pressure on the dollar, particularly USDJPY. While traditional finance deleveraging occurs over days and weeks, crypto deleveraging usually happens in one swift cascade. This could trigger a second round of yen carry trade unwinds.
Elections typically boost equity markets, but given the divided nature of U.S. society, there’s a risk of a turbulent transition, potentially leading to prolonged protests and nationwide riots. Countries like Iran and Russia might exploit a distracted White House to increase their military operations abroad. Moreover, the U.S. government still holds a substantial portion of seized Bitcoin assets, which could flood the market if released, offsetting any positive momentum from FTX repayments.
Lessons for Traders
Summer liquidity is generally lower than the rest of the year, so traders should prepare for this seasonality by either reducing their leverage or increasing their cash allocation to improve their average entry price. While it might be tempting to buy VIX futures, the reality is that the VIX is often in contango, making it an expensive and unproductive endeavor.
One strategy for navigating choppy and bearish conditions is pair trading, where a portfolio of long assets is offset by a corresponding basket of shorts. For instance, a trader might want to be long Bitcoin but hedge against potential drawdowns by shorting assets like Litecoin or ADA. This approach allows traders to benefit from market uptrends while providing downside protection. Ultimately, the best preparation is to have a plan to buy during periods of fear and sell during euphoria.
Directional Positioning
Pair trading is often misunderstood as sacrificing too much upside, but that’s not necessarily true with the use of cross margin and sensible leverage. For example, if a trader anticipates a 10% move up in Solana (SOL), they can mitigate risk by trading SOL/ETH. This strategy allows capturing a 5% move with 2x leverage, offsetting potential losses on the short ETH leg. This approach is particularly powerful on the downside, as it enables traders to profit regardless of broader market movements.
Other instruments from traditional finance, such as 0dte options on crypto, are also making their way into the market, offering new opportunities for traders.
Funding and Market Dynamics
Negative funding in large-cap assets like ETH can be misleading. For example, ETH funding is historically low due to systemic selling of ETH perps by Ethena labs to maintain stablecoin issuance. Funding variance across platforms often reflects the user base’s behavior rather than market direction. Many traders, having lost significant amounts of money, resort to revenge trading with high leverage, leading to frequent stop-outs before funding costs can reset.
TradFi Margin Calls and Crypto Bounces
TradFi selling comes in two forms: discretionary and algorithmic. When volatility spikes, momentum funds, risk parity algos, and other systematic strategies start selling risk assets, including equity futures. Once volatility subsides, these models reset. However, discretionary allocations unwind more slowly, often taking days or weeks to process trades without causing panic.
Impact of Rate Cuts
The U.S. Federal Reserve’s potential rate cuts have been a hot topic. While some, like Wharton’s Jeremy Siegel, advocate for immediate cuts, others like Parker Lewis argue that the real impact occurs after the Fed starts cutting rates. Huf believes that the market context is crucial. If the Fed cuts rates in an economy that’s still relatively strong, the delayed response might lead to short-term relief but long-term volatility as expectations diverge from reality.
Conclusion
In these volatile times, traders must be prepared for rapid market shifts. The key is to have a well-thought-out plan, leveraging strategies like pair trading to navigate both uptrends and downturns. As always, the best approach is to buy during periods of fear and sell during euphoria, keeping an eye on broader market dynamics and the potential impact of rate cuts.
