The psychology of market cycles :
The psychology of market cycles is a fascinating topic for me that intersects finance, economics, and human behavior. This article explores the intricate dynamics of market cycles, shedding light on the psychological forces that drive them, accompanied by illustrations that depict various phases and examples as depicted below.
Market cycles refer to the long-term pattern of peaks and troughs that any market experiences over a period. These cycles are influenced by a variety of factors, including economic indicators, corporate earnings, geopolitical events, and most notably, human psychology.
The Role of Psychology
Speaking roughly , We can understand the market cycles in 6 phases as in the picture below :
It might take multiple years to complete one cycle as seen in long term perspective and also it is equally important to notice the mini versions of the below cycle over the short term.
Emotions significantly influence investment decisions, driving the market in distinct phases:
- Optimism: It starts with optimism, where investors begin to notice positive signs in the market. Prices start rising slowly, and early investors begin to profit, drawing more people into the market.
- Excitement & Euphoria: As more investors join in, excitement builds. Prices skyrocket. The euphoria phase is characterized by a belief that the prices will continue to rise indefinitely. This is often when the market is most overvalued.
- Anxiety & Denial: Once the market peaks and starts to decline, investors initially feel anxious. They believe it might be a temporary setback. As the decline continues, denial sets in.
- Fear, Desperation, and Panic: What follows is fear, quickly turning into desperation and then panic as prices plummet. Investors sell off their assets in a hurry, leading to a sharp market decline.
- Depression: After the market bottoms out, investors are left depressed, with many swearing off investing. It is usually the phase of the maximum financial opportunity.
- Hope & Relief: Gradually, as the market stabilizes and starts to pick up again, hope returns, followed by relief. This marks the beginning of a new cycle.
Market Crashes in the recent history ( Now you compare where the market are right now.)
- The Dotcom Bubble (Late 1990s – Early 2000s): During the late 1990s, there was a rapid rise in U.S. technology stock equity valuations fueled by investments in internet-based companies. It was a period marked by extreme euphoria and overvaluation of companies. The bubble burst in the early 2000s, leading to a significant market correction.
- The 2008 Financial Crisis: This was Triggered by the collapse of the housing market and subprime mortgage crisis, this period saw excessive risk-taking and over-leverage by banks. The optimism and greed turned into fear and panic, leading to one of the most severe global recessions.
- COVID-19 Market Crash (2020): The outbreak of the COVID-19 pandemic caused a global economic shock. Initially, there was panic selling due to fear and uncertainty. Markets quickly recovered, however, showing resilience and adaptability.
How to Navigate through Market Cycles ( Few of core Principles not limited to..)
Understanding market psychology can lead to more informed investment decisions. Here are some strategies:
- Awareness: Be aware of where the market might be in the cycle. Understand the sentiments driving the market.
- Diversification: Diversify your investment to mitigate risks. Don’t put all your eggs in one basket.
- Long-term Perspective: You should have long-term perspective in the mind as Warren Buffet Says
- Discipline: Stick to your investment plan and avoid getting swayed by market euphoria . I will illustrate you with an example – Let’s say a stock spike by 20 percent in a market it doesn’t mean that you need to buy ( in other words dont fall for FOMO factor)
As you want me to sum up in one sentence on the making a decent profits in stock markets
“In stock markets, your intelligence or skills matter only 5%, and rest 95% comes from discipline”
Cheers
Srikanth
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