Cryptonomics: Market Cycle Psychology Explained

Market-cycle psychology suggests surprising thought patterns behind market fluctuations. Investors should be aware of how the psychology works

By
Utulu Hope
on
May 5, 2021
Category:
Cryptonomics

 

Introduction

The present volatility of the global market makes it easy for any traditional investor to be emotionally unstable. An investor may end up devastated after checking the price of stocks and monitoring markets. Therefore, it is essential to know that your emotions can be affected by fluctuations in the stock market. It is important to adopt the right attitude whenever a sudden market change occurs, and to understand why the market is fluctuating. One school of thought suggests that the market-cycle psychology behind these sudden swings is crucial to benefitting from them.

Introduction to Market-Cycle Psychology

The phrase  "market-cycle psychology" combines two words — market-cycle and psychology. Psychology refers to the functions of the human mind and how they affect behavior. Market-cycle relates to the patterns that different markets attain at a given period.

Combining these two terms, this psychology insinuates the human mind plays a considerable role in market patterns and trends. In this article, we will show the relationship between market-cycles and psychology, and how investors can benefit from understanding this.

What is Market-Cycle Psychology?

Market cycle psychology refers to the emotional reaction of traders to respective market trends. Just as psychology has to do with human behavior, market-cycle psychology is human behavior towards the sudden changes in a given market. Analysts use the term often whenever explanations of the sudden change in price movements are needed.

Human emotions and behavior are the leading causes of market fluctuations. This means that an investor's sentiment or attitude is the foundation of market-cycle psychology. Market psychology has to do with investors' views towards the rise and fall of asset prices.  

There are two specific terms when explaining the market's volatility. The terms bullish market and bearish market are direct consequences of a shift in a given asset price. A bullish market is when there is favorable market sentiment. Here, the prices of goods rise at a constant rate. In contrast, a bearish market is when there is unfavorable market sentiment. Here, the cost of goods declines at a steady pace.  

Individuals influence the overall sentiment of a given market. Therefore, a bullish or bearish market results from the conceptions of investors and individuals of that particular financial market. According to theories of market psychology, change is a dynamic process. The price of an asset can change instantly, depending on the attitude or sentiments of individuals. It may be challenging to carry out successful transactions if investors are emotionally rigid, so prices of assets tend to shift because human beings are generally emotionally unstable.

Emotions Affect Market Behavior

The activities of a given market are dependent on traders' emotions. For instance, when an asset's price increases, it is always associated with traders' positive attitudes. In economics, the higher the demand, the higher the price and, subsequently, a reduced asset supply. So, when there is a positive sentiment amongst traders, there is a bullish market.

Similarly, when traders' attitudes are negative, there will be increased supply due to a price decline, which leads to a bearish market. These explanations show that human emotions affect market behavior.  

Consequences of Market-Cycles on Psychology

Although investors' attitudes may influence the market, they can still change — increase or decrease independently. Now, here's the big question: what happens when there are changes in the market-cycle, and how do they affect an individual's psychology?  

  • Consequence of a Bullish Market on Psychology

There are several emotions associated with a bullish trend. An individual may become optimistic, and others greedy or even both at the same time. However, these emotions will lead to an increased demand for the asset.  

The consequence of these emotions on a bullish market will be explained as we proceed. Let's take, for instance, the price of an asset increases as the emotions of investors remain positive — continuous bullish sentiment. If the price continues to increase at a steady rate, it is wise to predict that the interest level may drop. However, let's assume that demand for assets increases with inflated prices.

This is where greed comes in. Because the market keeps increasing with constant positivity from individuals, many individuals take advantage of the bull run. They tend to buy as much as possible with the hope of a continuous increase in the market cycle, giving less concern to its volatility.  

This act of greed continues, and the market gets to a breaking point — an over-extended bull run. At this point, maximum financial risks are inevitable. Judging by past cyclical trends, the market starts to undergo a considerable downslide because it can no longer sustain the continuous increase. An effect of the sudden downslide is the loss of dividends.

  • Consequence of a Bearish Market on Psychology

Now, let us look at the opposite of what was explained earlier. The primary emotion associated with a bearish market is complacency. Yes, the market is down, and traders are leaving the market. Even with this forboding, some investors would still believe that the bullish run has not ended.

This type of market leads to traders becoming anxious. Traders in this scenario may start looking for answers trying to justify their beliefs of a bullish run. They tend to hold their assets even as the run keeps declining. What then happens when the prices drop further?

When the price of an asset declines, selling activity increases. At this point, many investors become afraid, and the market eventually capitulates. The market capitulates when every holder of an asset sells towards rock bottom. However, the market may become stabilized later on, and hope is restored. 

 

How to Exploit Market-Cycle Psychology

Understanding how psychology affects the market cycle has a few benefits. There are two notable elements in increase and decrease tendencies. First, the market tends to be very productive when a lot of people are psychologically down. Secondly, when people are psychologically upbeat, the market tends to decline. Therefore the market cycle is counter-productive.  The moment traders realize the sentiments of individuals in a particular market; it becomes straightforward to profit. However, this ability to use psychological information to increase their yield is uncommon. Many traders are still able to benefit from other patterns that follow this psychology, thereby indirectly using the psychology to increase yield.

This means that as a trader looking to benefit from the uncertainty of the entire trading community, you need to buy when prices are low and sell when prices are high. This seems to just be common sense, but there’s a reason that it’s common sense - because it is so crucial to making successful trades.

This concept may not be easy to master, as buying the dip can still lead to even more unforeseen drops. Therefore, many investors resort to using market analytics to monitor price movements. Market analytics involves using tools that show the psychological state of a market at a specific time, allowing users to make trades based on analytical trends.

Closing Remarks

While market-cycle psychology is a generally unproven field, there is enough circumstantial proof to give it a second thought. While some psychology may seem to be opposed to surface movements, watching how the market performs as a whole seems to reflect the claims of the psychology. Investors should be aware of how the psychology works and how to speculate trades using that information.

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Utulu Hope

UC Hope is a passionate fan of crypto who could weave the latest event into sparks of inspiration and information. He leaves no stone unturned to get to the core of a story. Aside from writing, he spends his hours poring over algorithms and protocols, preparing for a future career as a computer programmer.