Psychology of a Market Cycle – Best Kept Secrets To Know [2023]

Psychology of a market cycle is quite an important topic to discuss. I’ve had the good fortune to know some of the best traders and investors of our time, and one of the many things they all have in common is an exceptional understanding of market cycles, how they work, and which cycle is currently in play.

Table of Contents

• What is a market cycle?
• Why Study the Psychology of a Market Cycle?
• Market Phases and Psychology of a Market Cycle

Traders and investors can shift the odds in their favor by understanding the current state of the market and psychology of a market cycle. They can also be flexible about when to play aggressively and when to reduce bet size, which are two of the most important factors in successful trading.

There are three ingredients for success—aggressiveness, timing and skill—and if you have enough aggressiveness at the right time, you don’t need that much skill.

 Howard Marks

As a result, it is critical that you understand the psychology of a market cycle and how market psychology influences the outcome and returns over time.

What is a market cycle?

A market cycle is defined as recognizable patterns that repeat themselves like trends as a result of larger tendencies of market participants.

Psychology of a market cycle is formed by two dominant emotions, fear and greed, which cause euphoria and depression. 

On a regular basis, global events like war, technological advancements, shifts in the global order, economic booms and busts, inflation, and climate change take place.

The majority of market-influencing events are either positive or negative. 

Positive events produce greed euphoria, whereas negative events produce fear and depression. These factors combine to produce swings that eventually become market cycles.

Why Study the Psychology of a Market Cycle?

The best traders and investors never ignore market cycles; they analyze patterns and psychology of a market cycles from the past, and they are always aware of the current state of the market and the implications of their actions.

You can begin by asking yourself a few questions to gain an understanding of where we are in the market-cycle.

• Are we on the verge of an uptrend, or are we already in one?

• Is the current trend exhausted, or are we in a reversal zone? 

• Is the current market cycle driven by greed or fear? 

• What about the current market prices; do they justify price action?

• Taking everything into consideration, are our market positions defensive or aggressive?

• Which phase of market justifies psychology of a market cycle currently in place.

We can gain some very valuable insights by closely examining market structure and psychology of a market cycle, which can tip the scales in our favor.

They can give us information on how to make future plans without necessitating our capacity for future prediction.

Market Phases and Psychology of a Market Cycle

Market cycles are caused by the fourteen psychological factors , each factor explains psychology of a market cycle :

1. Disbelief:- Stage where most of the market participants feel market upswings as bull traps. The majority of traders and investors oppose any upward movement. Participation of smart money, which accumulates value stocks at low prices and sometimes proves to be the most profitable in the long run, is an interesting aspect of this stage.

2. Hope:- Once the market has spent some time consolidating and failed up moves, the phase of hope begins. It usually begins when market swings exceed previous swing highs. This price action encourages some traders to take small position sizes.

3. Optimism:- Prices making higher convince more traders and investors to join the rally. In this stage, cautious price movements are anticipated. Government policies and the overall economic environment support optimism.

4. Belief:- Trend is visible now to most of the market participants. The market phrase is “buy on dip.” Positive company returns reinforce current sentiments.

5. Thrill:- The majority of traders and investors are sitting on massive profits. Thrill of buying more prevails in markets. More capital and investments are flowing into the markets. Price speculation is rampant in secondary markets.

6. Euphoria:- Excessive valuation speculation. Investors and traders believe that the market will never reverse. Everyone is bullish and trying to participate with aggressive bets.

7. Complacency:- When prices begin to fall from all-time highs, no one wants to believe it is a sign of a trend reversal. Market participants become overconfident in their ability to make money and continue to believe that “buy on dip” is a good idea. Most traders and investors mistook the price decline for a normal correction.

8. Anxiety:- Anxiety is prevalent when the market keeps falling after a few lower swing highs. Market participants are concerned about leaving profit on the table. Smart and skilled investors have completed or are about to complete profit booking.

9. Denial:- Aside from smart money, all participants adhere to the “hold and watch” philosophy. They are still unable to accept the reality of the market situation and are in denial mode. They simply observe the bleeding portfolio and hold a long-term investment philosophy.

10. Panic:- When markets continue to fall beyond everyone’s expectations, everyone panics. Investors are attempting to determine the causes of the fall and creating a false sense of future recovery. Some traders or investors attempt to reduce their positions but fail because prices continue to fall.

11. Capitulation:- More and more people join in selling rally. Every piece of market news has become overly negative. Smart money looks for opportunities and begins its research.

12. Anger:- Investors are irritated by the current socioeconomic situation. Start to blame government policies. Enraged by the bull run’s lost profits.

13. Depression:- Traders and investors reflect on their folly in losing bull market profits. Many traders and investors eventually leave the market, making way for new entrants. Volume falls significantly, and liquidity in secondary markets is also low.

14. Disbelief:- Phase one of the market cycle is back in place. Smart money has done its homework and discovered new opportunities in undervalued stocks. The accumulation process begins with small upswings.

Bottom Line

Finally, I’d like to emphasize a few additional critical aspects of psychology of a market cycle and psychological influence in markets.

1. Market cycles are an inevitable part of the financial system, regardless of how people cite changes in geopolitical, technological, and economic factors, it is important to know about psychology of a market cycle.

2. Nothing is new in trading and investing because human emotions are always the same, so market cycles will repeat themselves as they have in the past.

3. John Kenneth Galbraith’s A Short History of Financial Euphoria (1990) has given a very important point regarding market cycles, It essentially tells us how most recurring financial patterns and financial disasters have gone unnoticed by new and younger generations. And hence the cycles repeat. 

                           “extreme brevity of the financial memory”

4.  I would not say that understanding psychology of a market cycle alone can help traders or investors, but it is an important part of a larger picture that, when viewed as a whole, appears far more reasonable than when viewed in pieces.

5. It all boils down to being reasonable, aware, and not losing sight of what is going on and where we are in the market cycle as well as in life.

 Frequently Asked Questions

Psychology of a market cycle infographic

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