Understanding Market Movements

All most people see when the market is falling or rising rapidly is a trend, which they assume will continue. When the market has jumped way up, they buy stocks. When it’s dropped, they sell. In the short term, the market may continue to move in the way they’ve observed. But sooner or later the trend will reverse. Understanding how markets turn can help you do better with your investments.
Explaining Market Turns
At any given time, there are a large number of players and potential players hovering around the stock market. When most of those players are bullish, most of them are actually in the market. Once they’re all in, there’s no place for the market to go but down. For a while, good news may keep things going. People will buy on margin or borrow money to sink more funds into the market when things are booming. But eventually, they run out of cash. The slightest bit of bad news will then send the markets hurtling downward.
The opposite thing happens during a slump. A few buyers turn bearish and take their money out. Prices drop, so more people follow. Pretty soon, the majority of participants are selling, and prices drop further. What happens eventually is that the bulk of potential buyers are sitting on the sidelines, and all the sellers have already sold. When this happens, any bit of good news will send prices soaring, because there is plenty of money ready to invest.
Waiting for Capitulation
Capitulation is a term used by finance professionals to explain what happens during stock market crashes. When a bout of selling is exacerbated by bad economic news, wholesale panic sometimes results. A few investors hold on, hoping to recoup their losses on recently purchased stocks or expecting an immanent turnaround. But if the losses are steep enough, most of them eventually give up and sell too. The final wave of sales is called capitulation. Once it’s happened, the market is well positioned for an upturn. Sometimes it takes some positive news to start the upswing, and sometimes a general perception that stocks are oversold will do it.
While these cycles seem very clear on paper, they’re much more difficult to identify in practice. Many of the very best investors maintain that it’s better to simply buy stocks when the companies are on sale and ignore the fluctuations of the market.
If you do attempt to play the cycles, remember that it may be better to miss the top than to hold too long, and better to miss the bottom than to buy in too soon. If you buy sound companies at great prices and are holding for the long term, your ability to time the cycles will eventually matter far less than you might expect.