Markets have a lot of short-term uncertainty, perhaps more than most people realize or are willing to admit. At the heart of market dynamics lies a straightforward yet profound principle: every fluctuation in price, whether slight or substantial, derives from market participants’ expectations about future outcomes.
By Yvan Byeajee, author of Trading Composure: Mastering Your Mind for Trading Success
To reiterate, the entire dance of numbers that we observe on market charts — every uptick or downtick — is, at its core, a manifestation of collective expectations about what lies ahead. This principle is so central that understanding it is crucial for anyone looking to decode the mysteries of financial markets.
Let’s distill this intricate mechanism into a more relatable scenario. Imagine you are in a cozy room with nine other people, and in your possession is an alluring painting that has piqued the interest of the others. The dynamics of this room closely mimic a market, where the people represent participants, and the goods or services they’re interested in trading are represented by the painting.
Suppose you’ve tagged your painting at a value of $200. Another person, deeply captivated by the artwork, offers you $210. But what prompts this individual to propose a higher price than the sticker amount? Well, the answer is rooted in their expectations of the future. By offering $210, the buyer is signaling their belief that the painting’s value will escalate beyond the current price. They anticipate that either the demand for the painting will rise or some external factor will amplify its worth. This is a speculation, a bet on the future.
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The sale culminates at $210. Fast-forward, the same buyer now intends to resell the painting. He pitches a price of $220 but finds no takers. However, after gauging the situation, an observant individual in the room considers $215 a justifiable amount and offers to buy it at that price. Again, beneath this offer lies a conjecture about the future. In offering a price lower than the asking rate, the buyer is signaling a lower level of confidence in the artwork’s potential appreciation. The seller agrees to the transaction, securing a $5 profit—after all, profit is profit.
In a dramatic twist, the room buzzes with whispers that the painting is the work of a renowned artist. Its perceived value skyrockets within seconds. Bidding wars ensue, and in a whirlwind of transactions, the painting lands a price tag of $600. Such is the volatility infused by information and sentiment in our hypothetical market.
Later, doubts creep in; the high-roller who splurged $600 on the painting grapples with buyer’s remorse. The demand dips, and he’s forced to reconsider his asking price, settling at $425, reflecting the shifting sentiment in the room.
Does this seem familiar? It should be because this ebb and flow of prices based on collective beliefs and speculations, scaled up millions of times, is precisely how global markets operate. Replace the room with the world, the 10 participants with millions of them, and the painting with stocks, commodities, forex, or cryptocurrencies, and you have the intricate tapestry of financial markets.
Understanding what makes the market tick
Every “tick” — the most minor change in price for a traded instrument — is the market’s heartbeat. It encapsulates the consensus at that fleeting moment, representing the aggregate of all buying and selling pressures. An “uptick” transpires when the aggregated weight of buying exceeds selling. This means that traders are ready to pay more than the last listed price. But what drives them to this stance? It boils down to their perception of the future.
If they are of the conviction that the current price is undervalued in comparison to its potential future value, they are inclined to buy at a rate higher than the previous transaction. This act of buying at a steeper price propels the overall price upwards. Contrastingly, a “downtick” emerges when selling pressure outweighs buying. In this scenario, traders are inclined to pitch prices below the most recent transaction rate. This behavior stems from the belief that the current price is inflated, forecasting a potential dip in the future. Thus, they quote lower prices, which, when transacted, drive the price downwards.
To simplify further, the direction of price movement is predominantly a function of the collective’s willingness to pay. This willingness is, in turn, anchored in expectations. These expectations are formed by an amalgam of factors—from hard data like news and fundamentals to softer variables like individual aspirations, emotions, and market psychology.
Each tick, whether upwards or downwards, gradually builds the larger picture we recognize as minute, hourly, daily, or weekly candlestick patterns on charts. Fundamentally, these movements reflect the constant tug-of-war between two predominant sentiments — optimism and pessimism — as they relate to the future. Prices tend to gravitate within a narrow band when these forces are balanced. This is a period characterized by reduced volatility, where neither sentiment has the upper hand.
However, price directions become more pronounced when one sentiment significantly overpowers the other. This could manifest as either an uptrend, driven by dominant optimism, or a downtrend, propelled by prevailing pessimism.
Ultimately, the magnitude and duration of these market movements lie in participants’ convictions. To reiterate, those with a firm expectation about the future, demonstrated by their purchasing or selling actions, often dictate the direction. An accumulated positive sentiment leads to rising trends, while an aggregated negative sentiment prompts downtrends. When neither sentiment holds significant sway, the market moves sideways, signifying volatility contraction. This dance, ceaseless and dynamic, is the lifeblood of markets, and understanding its nuances is the key to successful trading.
This is an edited extract from Trading Composure: Mastering Your Mind for Trading Success by Yvan Byeajee (published by Wiley, September 2024).
About the author
Yvan Byeajee is known for his work in the field of trading psychology and personal development related to trading. His approach centers on the discipline and philosophy of mindfulness. He is the founder of the popular trading psychology blog, Trading Composure.