Market, it is always confusing isn’t it? Well, if it goes up then people ask why, If it Goes down then also people ask why and if it does nothing, then also why? Every move of the market is confusing, thrilling and most of the times, unexpected. Can my readers follow through on what I am insisting?
Last year after Covid crash in March 2020, it was one way up for most of the Equity markets around the world! Best part, India is outperforming most of the Emerging markets. And it is a good thing for the country as a whole. We may call it a bubble but it has solid ground in reality as every bubble had in the past.
Ever heard people saying that, Market is just out of reality, we got covid crisis going on, the Economy is barely catching up and the market is just skyrocketing, this madness is not making any sense etc. Some of my readers also have the same opinion I guess. Let’s dwell further down the line on this talk.
When the market crashed in March 2020 due to Covid pandemic fear, everyone was certain that, because of the Covid Pandemic, the world Equity market had collapsed. Most of the people were also expecting fall to continue at that time, remember?
These two different phases, Covid crash and then extreme price stretch after that of the market are totally opposite. Opposite in terms of Emotions, price, valuation and even momentum. But in general people’s interpretation about both phases, rooted to the same thing i.e. cognitive bias and ego. Now I will try to explain and connect all the dots in a simple way below.
First of all, Wikipedia definition of cognitive bias is, “cognitive bias is a systematic pattern of deviation from norm or rationality in judgment. Individuals create their own “subjective reality” from their perception of the input.” It means individuals create their own perception of reality and then they see the actual world with this false(in most of the cases) perception. But why would one create this false perception in the first place?
Answers can be many fold, but there are two important causes that make sense in our case. Market participants always try to match ongoing events with the recent price moves of the market, which is just unpredictable!
Let’s say if there is a pandemic, then the market has to fall this much and in way it had fallen in the past reacting to stressed situation. So, first we got confirmation that this has happened, so it will happen again in exactly the same way!
Now, if you have seen markets in 2008-2009 periods(most recent crisis before Covid), then for that entire year downtrend has continued. Initial rapid down move was followed by recovery on the upside and then again market had touched initial low. Classic down-trend on the chart! For the entire year!
So, in March 2020, people simplified things after the initial explosive down move. The market has further downside and it will touch the initial low again! This conclusion has no ground in reality because even if history rhymes it does not repeat the same way.
But well, how about accepting the fact that, economy was really going on ? Again It’s just another simplification of uncertainty. It is not necessary that the economy and market are aligned every time and in every way.
On the way up, when the market as a whole started making new highs, people have not participated in the rally, because they are waiting for the downside and then when they get it wrong, their ego would not allow them to accept the fact. And this explains the confusing part of the up move.
Yes, that’s it. Cognitive bias and ego, these two explains ongoing emotions of market participation.
My two cents, the market in a pure sense exhibits some patterns but is random. There maybe thousands if not hundred variables that may/can affect prices of security at any given time. Problem begins when one wants to have a possible explanation for everything. Rather I would advise to focus on managing risk and not on being right every time. And yes, I also believe and it is statically proven that risk remains the same in respect of price. Means there is no difference in risk one would take by buying Nifty at 7500 or at 17500. Because if it would have been just buying low and selling High, then there would have been no market.
Until then Happy trading!