The Ecology of the Market

The stock market can be looked at in many ways: at its most macro level, it can be viewed as a reflection of the over health of the economy and at its most micro level, from second to second, it reflects the sentiment of twitchy-fingered traders trying to make money on movements of pennies. Using the tools on my laptop, at anytime I can view the market moving in real time with every trade or I can change my perspective to the more glacial movements of the market on a monthly or yearly scale. One of the interesting characteristics of the market is that if someone shows me a chart of minute-by-minute moves and a chart of yearly moves, without any scale on the X or Y axis, I could not tell you which chart is which. If you have ever heard someone refer to the fractal nature of the market, this is what they mean. Market movement looks the same at every scale. What this implies to me is that market psychology is the same on every scale. Fear and greed rule regardless of whether your trading time-frame is minutes or years.

One path to success in the market is being able to measure fear and greed. When fear is at its max, it’s time to buy and when greed is at its max, it’s to sell. Even Warren Buffet, who claims not to be a market timer, relies upon this idea. Read here.

Why does this adage make sense? When greed is at its apex, everyone is buying. This is a time when people who normally do not buy stocks start buying stocks because everything is going up. Here’s the thing: if everyone who has money to put into the market has done so, then there is no one left to buy and if no one is buying, stocks can only go one way – down! The inverse is also true about fear. When everyone has sold and there is no one else who wants to sell, then prices can only go up.