What Makes Markets Move?
Dare I say ‘shake that money maker’?
Let’s break this down a little…
Markets are supposed to move as the general consensus of ‘fair value’ of an asset changes with changing information. For example, when a company makes an announcement regarding their earnings forecasts (how much money they expect to make) the collective opinion of the market (what all the traders/investors think) will reprice that company’s stock accordingly. If the announcement was viewed as positive, the stock price will rise and vice versa.
But is the market really that efficient? Does the collective opinion of its participants really add up to an accurate evaluation of what a stock is worth…all day, every day?
Of course not.
So what makes markets move?
Human emotion moves markets.
Now, before some of you start jumping up and down waiving financial statements and economic reports hear me out…
Yes…broadly speaking…the price of quality companies appreciate over time as a reflection of their profitability. And yes…countries with strong economic growth (an expanding economy) will…over time…generally see a rise in the value of their currency (FX prices) and raw materials (commodities, traded using futures) which they either use (like China) or sell (like Australia).
HOWEVER…when the Dow falls 5% and the global markets all open at similar levels lower…the reaction is called ‘negative sentiment’…and if we look up the definition of sentiment we find:
Sen-ti-ment: A thought, view, or attitude, especially one based mainly on EMOTION instead of REASON.
And which 2 emotions are the most prevalent when it comes to risking money?
There probably isn’t an easier place in the world to make money then in the financial markets. A drunken monkey could throw a dart at a board, pick a stock and watch it go up and up and up on the zookeeper’s computer. Bananas for everyone.
When you watch your money grow at what can be an incredibly rapid pace your emotions kick in. Greed can take over and your decisions are now based on emotion rather than reason.
There probably isn’t an easier place in the world to lose money then in the financial markets (apart from maybe owning a boat). When you see your money evaporating at what can be a frighteningly rapid pace your emotions kick in. Fear can take over and your decisions are now based on emotion rather than reason.
It’s the emotion of traders/investors that makes markets fluctuate…sometimes severely.
Regardless of whether the emotion is in relation to a company announcement, an economic decision, a geopolitical event (such as a natural disaster or war) or a trading account’s health…it’s the collective emotions of participants causing the fluctuations.
It doesn’t matter where you were born, how you were raised, which language you speak or your opinion on Mariah Carey’s music success…we’re all tarred with the same emotions. When we’re losing money quickly we get fearful…and when we’re making it easily we get greedy. And it’s those repeated emotions – to different situations – that moves the markets.
So how do we capitalise on that knowledge to profit?
Well…that’s a lengthy topic in itself….but start with…
* You can use charts to identify patterns which repeat themselves. The price behaviour plotted on charts shows graphical representations of emotions… fear and greed repeating themselves in response to different situations.
* Take a ‘contrarion’ opinion of the market. If everyone is selling on emotion, surely reason would suggest prices are unrealistically low and it’s potentially a good time to buy…and vice versa. This is how the ‘smart money’ (experts) often capitalise on the less restrained emotions of the herd.
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