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Efficient vs Inefficient Markets: How To Tell The Difference?

Courtesy of the avalanche of levered-longs in recent weeks into the crypto market, alongside some negative newsflows in relationship to a sudden drop in BTC hash rate, we saw one of the most epic long liquidation episodes that the BTC/USDT chart has ever recorded on Sunday. To put the numbers into perspective, check below the ‘jaw dropping’ stats where over usd 9bn got rekt.

Source: https://www.bybt.com/pro/futures/LiquidationData

After such a violent washout of irresponsible longs in the crypto space, the BTC/USDT chart in particular ended up printing an outrageously disproportionate outsized candle as illustrated below. The capitulation-type movement from the latest all -time high circa 65k down towards 52k represented a sudden drop of value to the tune of 21-22% depending on the exchange BTC was traded.

So, in today’s lesson, I am going to make the distinction between what an efficient market looks like vs an inefficient one. I have no hesitation in sticking out my neck by stating that after the move that just happened, the BTCUSDT chart shows signs written all over the wall of a very inefficient move. Drawing this conclusion is key to understand what may come next.

Source: @edwardmorra_btc

In the left illustration, we can clearly see one candle standing out amongst the rest. That’s the first factor to qualify a market as inefficient. Secondly, identifying the main the narrative that led to such a drop is key.

In the case of Bitcoin, being a market with so much public access to data analytics, it is clear that the move was fuelled by a cascade of self-feeding sell stop triggers loop, combined with what appeared to be a brief spell of panic amid the drop of hash rate in the BTC network due to the blackout in a few Chinese counties that concentrate high mining power.

As a consequence, and having come to grips that no fundamental news warranted to act as a ‘meaty’ price disruptor, we can conclude that the market’s behaviour was highly inefficient. This tends to result in the move being filled back as a function of the price discovery.

In a way, it can be seen as an artificially inflated move caused by factors hardly able to sustain the overstretched valuations. In fact, a factor that I find to be very deterministic to judge a move long-lasting/sustainable and that ties nicely into what an efficient market looks like is ‘price acceptance’.

So, as we shift into the right-hand side illustration, what peculiarity in the price action chart do you notice that is distinctively different? Generally, there is no one single candle that sticks out, certainly not the way the left shot shows. What this constant rhythm and relatively even-sized candle formation tells us is a market that behaves much more efficiently.

Why? Because every time we make a new phase of price discovery, the bids and offers keep balancing out at lower prices. This ‘price acceptance’ is what’s required to initially build a new area of equilibrium. The more time that price spends at this newly-discovered price while consuming and filling orders, the stronger the argument to sustain the directional move.

To sum up, today’s lesson can go a long way in helping you understand the future behaviour of any asset class. It all starts by asking yourself the right questions. This brief article intends to shed some light on the key components that you should be looking at to truly grasp if the movement seen is justified or out of whack. An inefficient market tends to be a weak one to hold its trend.

About the author

Ivan Delgado

Ivan Delgado is a decade-long Forex Trader. Feel free to follow Ivan on Youtube. Join thousands of traders who follow Ivan's insights to increase their profitability rate by learning the ins and outs of how to read and trade financial markets. Ivan has you covered with in-depth technical market analysis to help you turn the corner.


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