In order to formulate guidelines for operating in the financial markets, it is necessary to examine their characteristics. Many of these are unusual, and others are unique to the markets, hence the difficulty for most people when they step into the market arena. As we discussed in the introduction, compared to the world in which we live, the financial markets are an alien environment, and participation in them is quite unlike any other activity. Normal thinking and behavior fail. A general understanding of the following market traits will help us in comprehending why our perceptions, emotions, impulses, and attitudes are inappropriate and let us down in the markets. We can then begin to build a framework for trading rules, discipline, and attitudes – a New Psychological Approach.
Markets Are Not Totally Determinable
All financial markets contain an element of random and unpredictable movement, sometimes called ”noise”. Hence, there are no certainties, no matter how soundly based the research or analysis, no matter how “well-informed” or prestigious a source of information, and no matter how confident we may feel.
Markets Discount the Future
Financial markets – especially stock markets – anticipate the future and move in advance of expected events, rather than waiting for those events to materialise. This is known as discounting. It is the reason why the stock market can be six to nine months ahead of the economy. If the economy is at present going through a bad patch, but is expected to begin a recovery in the near future, the market will take that into account in its present valuation. Conversely, if economic conditions, at present, are booming, the stock market may begin to fall, anticipating a downturn in the economy in six months’ time. In a similar manner, shares may fall on the announcement of good results simply because this had been expected and was already built into the share price. Nor is it uncommon for a share to go up on the announcement of bad news, the market taking the view that the worst is out of the way and things can only get better. Another aspect of discounting relates to price movement when the anticipated event does not occur, or at least not to the extent expected. Here, the market will usually give back some or all of its gain/loss in the absence of the hoped-for or expected news.
Markets Move in Trends
The whole subject of technical analysis is founded on this premise. Indeed, all investors assume this to be the case, whether they realise it or not. Without the presence or prospect of a trend, how can one take a position and expect to make a profit? A corollary of the above is that a trend in motion is more likely to continue than to reverse.
Market Fluctuate
Even when a price trend has been established in one direction, there will be movement in the opposite direction, possibly several times during the course of even a single day.
Price Trends Do Not Go On Forever
How far a trend can run before reversing will vary depending on the type of market, e.g., a stock market index will generally have a different capacity compared to an individual stock; individual stocks will vary according to their volatility, capitalisation, and marketability. Currency markets may have constraints, both internal and external, bond markets will behave differently from stock markets, etc., etc. Notwithstanding the fact that markets have different capacities for unidirectional movement, you can be sure that at some point, any trend will be checked and corrected. The one exception to this is the stock, which is in terminal decline. Here, of course, it is perfectly possible for the price to continue in a downward direction all the way to zero. In the Past, I had seen the likes of Phillips, Marconi, Fall to Zero, BUT in my Trading career, and also a First for many Veterans, was when we saw OIL Drop to Minus 40 in the year 20 April 2020 (20/4/20 Palindromic date??)
Markets Can Spend Long Periods Ranging
Markets can spend up to 70% of the time moving sideways, so while trends are to be expected, they are not necessarily going to be the dominant action for any market.
Markets Can Change Rapidly
Everything may have looked fine yesterday, but in the markets, tomorrow is another day – and another market. Continuity is not guaranteed, and as quickly as the market hands out profits, it can take them back and hand out losses.
MARKETS CAN MOVE RAPIDLY
It is possible to be a lot further ahead or behind next week, or even tomorrow, than you are today.
Markets tend to overshoot and can move to Extremes
market in an established trend tends to overshoot. This occurs due to the speculative interest that is attracted to any market that has been moving up or down for some time.
Over Time, The Market can do (almost) anything
A major stock market index is not going to drop 77% overnight, but it could over a period of time.
Anything the Market has done before, it can do again
We are assuming here that there are no external constraints placed on the market as a result of what happened last time, e.g. circuit breakers in computerised trading, exchange limits on price movement in any day, etc. (Ecclesiastes 1:9 “There is nothing new under the sun”)
The Market Will Always be There
If, for whatever reason, you quit the market, it will be there when you return. There will always be another opportunity. Now that we have an appreciation of the nature of the market environment, we can develop the psychology for dealing with it.
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