The crypto market had a bit of a tumble on Tuesday, just after bitcoin reached its highest-ever price of around $69,200. Over about five hours, bitcoin and ether dipped roughly 15%, and riskier altcoins shed 20% to 40% of their value. Things did recover pretty swiftly, however. And that’s good because –believe me when I say this – it could have been a lot worse. Here are five warning shots that were firing just before the drop, which could help you prepare for the next one.
Warning shot 1: Meme coin madness.
Meme coins went ballistic before the drop. The popular frog meme coin Pepe (PEPE), for example, rallied around 700% in the month leading up to it. Meme coin projects like Pepe have zero utility, and they’re open about that fact. They’re simply vehicles for mass investor speculation. So the higher they go, the more cautious you should be about the state of the crypto market.
Pepe’s 700% rally in February and early March. Chart from TradingView.
Warning shot 2: Sky-high futures funding rates.
Back in 2016, Arthur Hayes and his fellow BitMEX exchange co-founders had a clever idea: perpetual futures contracts (a.k.a. “perps”). Perps let investors make long or short crypto bets with massive amounts of leverage, or borrowed money. Unlike regular futures contracts, perps don’t have an expiry date – and that means investors can (in theory) hold them forever.
But there’s a catch: funding rates. Think of these as the glue that sticks perp prices and actual crypto prices (i.e. spot prices) together. When perp prices rise above spot prices, traders on the long side pay regular funding fees to short-sellers (and vice versa). And when the market gets too frothy, those fees can get really expensive.
The funding rate heatmap below flashes orange when traders are essentially paying 100% or more of their position size in yearly funding fees to stay in their long (or “buy”) positions. Notice how all the coins and tokens were glowing orange on March 5th – right before prices headed south. Then after the plunge, those funding rates reset back to “green” (a much more affordable fee for long traders).
The funding rate heatmap flashes orange when traders are essentially paying 100% or more of their position size in funding fees (per year) to stay in their long positions. Source: CoinGlass.
Yes, funding rates can stay higher for extended periods – especially if crypto prices keep going up to compensate traders for paying those fees. But when prices start to dip or stall, traders in over-leveraged long positions can quickly start bleeding money. That’s usually when a lot of crypto selling happens all at once. Then, just to add fuel to the fire, traders also have stop-losses and liquidation price levels lower down. When those levels get breached, their positions are automatically sold by exchanges.
Warning shot 3: RSI heatmap.
The RSI heatmap is another useful tool for spotting when the crypto market might be getting too hot. It shows the relative strength index (RSI) values for bitcoin and other digital assets all in one place, giving you a bird’s eye view of the crypto market’s current risks.
The RSI measures the relative strength of buying pressure versus the relative strength of selling pressure. It ranges between zero and 100, with higher numbers showing more buyer strength (see our RSI guide for the full rundown). Normally, higher RSI numbers suggest buyers are in control and the uptrend is strong. But when those RSI values get too high across the crypto board, it can signal that the market is overheated – and likely due for a selloff.
I’ve included a current snapshot of the heatmap below. This one uses week-to-week prices to calculate the RSI values for each investment. When the average RSI value (orange dotted line) starts to creep above 70 and into “overbought” territory (red), the risks of a market pullback can escalate. Just keep in mind that the market can stay overbought for a long time, with prices moving higher still.
The relative strength index (RSI) values of different crypto investments, based on week-to-week prices. Source: CoinGlass.
Warning shot 4: Greed.
Warren Buffett’s famous advice is to “be fearful when others are greedy” – and you can certainly apply this wisdom to crypto. The Crypto Fear and Greed Index gives a market sentiment score based on how fearful (closer to zero) or greedy (closer to 100) investors are on a particular day. It factors in several data points to get its reading, including price volatility, momentum, social media sentiment, Google Trends data, and bitcoin’s dominance over the market.
On Tuesday, the index clocked up a read of 90, signaling “extreme greed” among investors. That kind of gluttony has only happened two other times since the index was launched back in 2018. The first was in July of 2019 (red) after bitcoin topped out at just under $14,000 and then headed much lower. But the second time (green) was a bit different: investors stayed greedy for a couple of months as the market ripped much higher (with a few big shakeouts along the way). Time will tell which scenario plays out this time around.
The Crypto Fear and Greed Index, which measures investor sentiment. Source: alternative.me.
Warning shot 5: Wild volatility.
One of my favorite crypto trading strategies is to buy when volatility is low and sell when it’s high (assuming prices are going up, of course). And here’s why. When the market is dull (i.e. low volatility), that generally signals that it’s gearing up for a bigger move. Then as prices start to rise, volatility tends to perk up – increasing the odds of a quick downward move. So, the general idea (among other things) is to lock in some profits when volatility enters the danger zone.
To gauge where that is, I look for red bars on the Bollinger Band Width Percentile Indicator, below. Essentially, it means the Bollinger Bands are relatively wide, meaning volatility is extremely high. Check out our Bollinger Bands guide to go deeper into the weeds on that one.
The indicator was created by The_Caretaker and was first featured on Eric Crown’s YouTube channel. Chart from TradingView.
Notice above how the bars are still red for bitcoin. That doesn’t necessarily mean its price will come down now: it could just as easily mean the crypto needs to cool off a bit before its next leg higher.
What’s the opportunity here?
In hindsight, there were signs that the crypto market was getting a tad overheated and a big down day had been long overdue. If you’re bullish on crypto, you’ll want to use dips like these to top up your position. Because, as we saw on Tuesday, they can happen pretty fast and may not last long. On the flip side, they can sometimes be the start of something worse. So, keep an eye on those warning shots. And when they fire again, remember: nobody ever got poor by taking a profit.
