Market Cycle Psychology - Where are we in the cycle?
Before we get to the "where" question, let's first briefly consider the question "What is market psychology?".
Market psychology is the idea that market movements reflect the emotional state of market participants. It is one of the main themes of behavioral economics, an interdisciplinary field that studies the various factors that precede economic decisions. Many believe that emotions are the primary driver of change in financial markets and that general fluctuations in investor sentiment are what create so-called psychological market cycles, which are also dynamic.
Stages of investor emotion:
⚫️ Optimism - a positive outlook inspires us for the future, encouraging us to buy stocks.
⚫️ Excitement - After seeing that some of our initial ideas are working, we begin to consider what our success in the market might allow us to accomplish.
⚫️ Thrill - At this point, we investors can't believe our success and start commenting on how smart we are.
⚫️ Euphoria is the point of maximum financial risk. Once we are convinced that every decision leads to quick and easy profits, we begin to ignore risk and expect every trade to be profitable.
⚫️ Anxiety - The first time the market moves against us. Never looking at unrealized losses, we tell ourselves that we are long-term investors and that all of our ideas will eventually work out.
⚫️ Denial - When markets haven't recovered but we don't know how to react, we start to deny either that we made the wrong choices or that things aren't going to get better anytime soon.
⚫️ Fear - market realities become confusing. We believe that the stocks we own will never change in our favor.
⚫️ Desperation - not knowing how to proceed, we grasp at any idea that will get us back to breakeven.
⚫️ Panic - having exhausted all ideas, we don't know what to do next.
⚫️ Capitulation - Having decided that our portfolio will never grow again, we sell all of our stocks to avoid any future losses.
⚫️ Dejection - After leaving the markets, we never want to buy stocks again. This often marks the moment of greatest financial opportunity.
⚫️ Depression - Not realizing how we could have been so stupid, we are left trying to understand our actions.
⚫️ Hope - Eventually we come back to the realization that markets move in cycles and start looking for the next opportunity.
⚫️ Relief - By buying stocks that turn out to be profitable, we regain our faith that investing has a future.
It is difficult to predict with certainty exactly where we are in the market cycle, we can only make an educated guess as to the approximate stage based on the available data. And here is the Trading Psychology - Fear and Greed Index indicator.
Conclusion:
As investors, we always get bogged down in daily price movements and lose sight of the big picture. The biggest crashes do not happen when investors are cautious and fearful, but when they are euphoric and expect financial instruments to continue to rise. So as you continue to invest, remember to stop and ask yourself: where on the chart do you think we are now? The market psychology cycle sheds light on how emotions evolve, the fear and greed index can be useful provided it is not the only tool used to make investment decisions. It's easy to look back over market cycles and realize how general psychology has changed. Analyzing past data makes it obvious which actions and decisions would have been most beneficial. However, it is much harder to understand how the market changes as it evolves, and even harder to predict what will happen next. Many investors use technical analysis to try to anticipate where the market is likely to go. Investors are advised to watch out for fear of potential buying opportunities on dips and view periods of greed as a potential indicator that financial instruments may be overvalued.