Success in financial trading has mastering the price vs. time conundrum as a prerequisite. Regardless of a bearish or bullish market pulse, it’s a must to decipher the market cycle vs. emotions dilemma to reap profits.
Emotional control is central to profiting in the global financial markets. Such failing traders tend to hold on to negative emotions when these are not supported by the market.
Profiting traders tend to exhibit the right emotional control at just the right time to initiate the best trading calls.
It’s well-understood that the financial market undergoes cyclical movements. During these movements, the market participants also feel varied emotions, shaping their trading psychology.
In this article, an attempt is made to put forward the struggles playing in the minds of market participants. In that context, let’s attempt to clearly comprehend what the psychology of a market cycle tells us in a simplified manner.
The image above depicts various emotions that come into play when market participants trade. Let’s examine these one-by-one:
1. Disbelief
After a bear market, when a fresh trend enters the market, the disbelief emotion comes handy.
While skeptical traders feel like the incumbent rally will fail just as other rallies failed, optimistic traders get hopeful. To begin with, short-sellers tend to cover their short positions.
Veteran investors venture into the market whereas novice players doubt the rally’s potential. While veterans are driven by their own meticulous analysis, minimal market knowledge tends to hold amateurs away from the market.
Fear of missing out or FOMO steps in the minds of amateur doubters as the rally soars. Regret follows if they enter at a rising (costly) market trend phase.
2. Hope
A recovery is possible. In this phase, the ongoing price rally settles down to consolidate and retrace. While the market participants exhibit hope in the market potential, the FOMO-struck skeptics gradually enter the market. As a result, accumulation begins.
3. Optimism
The rally is real. The zealous market momentum ushers in an influx of investors to get a pie of their own from the rising market. Optimism is omnipresent. The news media is all over the market momentum as the boom phase sets in.
4. Belief and Thrill
All-in on investments at margin, whilst also persuading others to buy. This phase is filled with robust news media coverage of the market. This is where the real FOMO sets in, wherein a large number of buyers enter the market. The said rally exhibits tendencies of continuity.
FOMO-filled investors motivate their acquaintances to enter the market. Too much of something is bad enough. As a result, overblown optimism leads to unintentionally-biased speculations.
5. Euphoria
Average Joe feels like a genuins, on the verge of being rich. Caution is extinct, it has got no room at this stage. Soaring asset prices quadruple valuations. Market analysts resort to a wide genre of metrics and valuation techniques just to justify the otherwise strange upswing.
The “greater fool” theory pops in—wherein, regardless of the price behavior, a buyer group is always ready to buy (even at high prices).
6. Complacency
The erstwhile investment genius shifts to the neutral gear, opting to cool-off for the next rally. Retracement follows, with a subsequent mini-rally fuelling a false hope that the uptrend would continue.
So, traders tend to not let go of their positions with an expectation that the rally would sustain. They perceive the retracement as a mere short-term phenomenon. But in reality, these traders miss the point that the market has got no more moves to make, that it is now poised to reverse.
7. Anxiety and Denial
Contrary to Joe’s expectations, the dip sustains, goes deeper. Joe fears the margin calls. The misled trader falls into denial, thinking that the invested companies are strong to return the capital anyhow.
Smart traders gauge the market bubble warning sign to book profits via positions’ selling. But our average Joe-like amateur retail investors act as bystanders. They expect the market to bounce back—which it doesn’t.
8. Panic, Capitulation, Anger, and Depression
Average traders see everyone selling, so they also plan to get out of the market. The market cycle experiences a drastic drop. The bubble bursts. The price drop defeats the price rise rally. The value of investors’ positions falls considerably as they receive margin calls.
This leads a number of market participants to initiate capitulation, liquidating their positions. The result is anger (questioning as to who shorted the market—it’s unfair), followed by depression. At the depression stage, dear Joe realizes their retirement money is fumes.
9. The Verdict
Master the emotions. Motion with the right financial market emotion. Ignore and avoid falling into the trap of baseless market cycle commotion. Pinch just the right pulse. People are prone to biases. Plan in advance, don’t FOMO.
