Thursday, January 7, 2010

Sentiments and Trend reversal in Markets.


We have seen that whenever a market is viewed by all participants as bullish, a trend reversal takes place and turns bearish. Likewise, whenever a market is expected to be bearish by all, it turns bullish against their view.

When Crude oil was trading around 145 USD in 2009, everybody is thinking it will go to 200 USD levels. The Media is bullishly covering Crude oil. Everybody is expecting the demand for the Crude to go up because of growing world Economy. Every Analyst has turned bullish on Crude, but it has turned otherwise. Crude fell from 145 USD to 30 USD within 6 months.

Why is this happening, when everybody is in one view but the Market turns otherwise? Let me explain the internal dynamics in it.

Market movement is influenced by demand and supply. There is always a demand or supply potential for a market. Demand is inversely proportional to Supply. If the participants in a market feel bullish about a particular market, they will start to accumulate the asset. Like this slowly, every participant acquires the asset. In initial stages, the demand potential will be high, but as the time progress and as more number of participants acquires the asset, the demand potential slowly recedes.

But the sentiment in the market will slowly turn bullish, as more number of peoples have already bought the asset. As this process continues, almost all of the Investors would have bought the asset and the sentiment would be highly bullish by this time.

Now the buying potential is already receded because the potential Investors have already bought the asset. Now a selling potential is created, as those who have bought it will sell it for a profit. As the buying potential recedes, a selling potential increases.

At some point of time, the demand potential and supply potential will be same. And after some time, demand potential will be overwhelmed by supply potential. But at this time, the bullish sentiment would grip the Investors.

At one point of time, everybody would have bought the asset and nobody is left, so everybody is highly bullish, but the selling potential would be at its highest and buying potential would be at its lowest in this point time.

This is the time, trend changes from bullish to bearish because of the change of balance of buying and selling potential in the market. That is why, even though the sentiment is bullish, the trend changes from bullish to bearish and vice versa.

Understanding the internal dynamics of the Market is essential for successful Investing.

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