The market is going to explode, so ‘the best preparation is to have a plan to buy fear and sell euphoria’ – Veteran Trader

Global markets blew up over the weekend, and the onslaught continued throughout the August 5 trading day, sending the Dow and S&P 500 down more than 1,000 points and sending Bitcoin (BTC) price below $49,000. Japan’s Nikkei 225 saw its worst one-day correction since October 1987, while Taiwan’s benchmark stock index saw its worst day of trading in 57 years.

With almost all markets closing lower on August 5, it is too early to conclude that the sell-off is over, but traders are likely wondering if it is time to think like contrarians and pick up discounted assets themselves.

To discuss what’s happening in the volatile markets this week, Cointelegraph spoke to Huff, founder of Pear Protocol, a decentralized exchange that allows traders to participate in trend narratives through pairs trading.

Cointelegraph: From your perspective, is there anything traders are getting wrong about the current global market and cryptocurrency crash?

Hoop: Most market participants are expecting a rally in Q4, with bullish factors including interest rate cuts, a new US government and crypto-specific positives such as FTX bond repayments.

I think they don’t quite understand that if we start cutting aggressively, there will be sustained downward pressure on the dollar and especially USDJPY. While TradFi deleveraging takes place over days and weeks, crypto usually ends in one cascade. Further decline in USDJPY could lead to a second yen carry trade unwind.

Elections are usually a positive catalyst for the stock market, but given the divided nature of American society, an uneasy transition to a new administration is dangerous, including prolonged protests that could escalate into nationwide riots. Other countries, such as Iran and Russia, could use a distracted White House to step up their military operations overseas.

Finally, the US government has yet to sell off a significant portion of its seized Bitcoin assets. A significant portion of these coins (excluding Silk Road) are locked up in legal battles with BitFinex and its users. If they win and receive Bitcoin, coins that were previously essentially out of circulation could enter the market, which could create Mt. Gox Part 2-style fears that could offset the FTX tailwind.

CT: As traders, are there better ways or lessons to be learned to prepare for, act and hedge against events like the last few days?

Hoop: Summer liquidity is always lower than other times of the year, so it is important to prepare for this seasonality. Traders should either reduce their size (reduce leverage usage) or increase their cash allocation to improve their average entry price to account for the differences in market structure during these summer months.

It’s easy to think that you can simply buy VIX futures, but the reality is that most of the time the VIX is in contango, and holding or rolling until expiration is an expensive and futile endeavor.

Since April, cryptocurrencies have been in a downtrend. One technique for dealing with these volatile and bearish situations is pair trading. That is, building a portfolio of long assets and offsetting the risk with a corresponding short basket. For example, a user may still want to be long Bitcoin but be concerned about a drop like today. One idea is to be long Bitcoin and short something like Litecoin or ADA. While the market tends to move around Bitcoin, you enjoy the upside, while the short leg protects against the downside.

As always, the best preparation is to plan to buy fear and sell euphoria. What makes this market difficult is that, compared to previous cycles where dogcoins marked clear local peaks, the memecoin craze lasted for weeks and months, providing an illusion of sustainability. The next time we see a limited pool of capital constantly rotating between narratives, it will be an indicator of late-cycle behavior.

Related: Ether Dump from Jump Trading: Smart Move or Sign of Trouble?

CT: Is there a better way to determine direction than by looking at potential mean reversion for a severely oversold asset like BTC? Ethereum and brush?

Yes, one of the misconceptions about pairs trading is that it gives up too much on the uptrend. This is not necessarily the case, since it uses cross margin and reasonable leverage. For example, a user may expect a +10% uptrend on SOL. This obviously puts a lot of risk on the downtrend.

However, with a trade like SOL/ETH, users can instead capture the 5% move and do so with 2x leverage. The profit from the long SOL leg offsets the potential loss from shorting ETH in a rising market.

But the real power of this strategy lies in its downside: if SOL goes down -5% and ETH goes down -10%, the user still makes money regardless of whether the broader market goes up or down.

Although pairs trading is not inherently market-neutral due to the beta and volume of the two assets, it offers an attractive way to use leverage to expand your horizons while also protecting against liquidation risk.

The transition from TradFi to other tools has begun, including 0dte options for cryptocurrencies, which IVX (based on Berachain) is currently pioneering.

CT: Do you think the lack of funding for large cap stocks is a lie?

Hoop: Funding has some unique elements depending on the asset and location. For example, ETH funding is historically low due to Ethena wraps and stablecoin issuances, which are a mechanism to systematically sell ETH puffs and suppress funding costs. Funding varies across trading platforms depending on whether users are aggressively long or short, so it says more about the user base and conditioned reactions (e.g. shorts) than it does about where the market is headed next.

The reality is that many people lose a lot of money, resort to revenge trading, increasing leverage and stopping before the funds actually reset and come in.

CT: How many days does it take for margin calls and unwinds to go away on TradFi this week compared to crypto? So if there is an immediate sell-off in crypto, does that mean it is a trap?

Hoop: Yes, there are two types of TradFi sells to watch out for: discretionary and algorithmic. When volatility spikes like it is now, a combination of momentum funds, risk parity algorithms, CTAs, and other systematic strategies will flip the signal and start selling risky assets, including stock futures. As volatility decreases, the models reset and the trend returns to neutral. Discretionary allocation, however, is often much slower. This involves risk and asset allocation committees slowing down the unwind or trading at smaller clips to create panic selling.

CT- Many analysts have long expected the U.S. Federal Reserve to cut interest rates, and on August 5, Wharton said Jeremy Siegel said The Fed needs to make an emergency rate cut. Meanwhile, Gradually and suddenly Author Parker Lewis said “It’s not interesting until the Fed starts cutting rates. That’s when the pain starts.”

What do you think about the interest rate cut and its potential short-term and long-term impact on the stock and cryptocurrency markets?

Hoop: It depends on the market situation. The Fed is cutting into an economy that has been relatively strong. GDP and employment have been quite strong up to the latest NFP data points. A rate cut (much like a rate hike) produces a delayed response in terms of loose credit conditions and higher consumption/spending.

In the short term, fortunately, the market has come out ahead, expecting a very aggressive rate cut path. Even if this does not materialize, if the economic data is good, it can provide some relief. In the long term, the greater risk to society is always inflation, and therefore the interest rate lever has proven to be an effective tool to control inflation.

Either way, prepare for increased volatility as we head toward the end of the year as expectations and reality diverge.