Because everything in our life is cyclical!
Stock Markets have a tendency to go through cycles – from complete despair (fear) to extreme euphoria (greed). Even though the stock markets have been around for decades and many new stocks have come and gone, the overall story of greed and fear still remains the same. But have you ever wondered why does the stock market go through cycles?
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1. Human Nature
The nature of an average person is irrational. If you want to lose weight, the best method would be to get on a workout and nutrition program and follow it consistently for few weeks/months. But nobody does that! An average weight loss journey starts with extremely strict workouts and diets and slowly leads back to binge eating & skipped workouts and back again to strict workouts and diets. So, rather than following a straight line to reach our goal, we often take a ‘cyclical’ path.
Stock market trading involves buying and selling stocks every second by such ‘irrational’ humans. Is there any doubt that the human emotions and sentiments cause cycles in the market?
2. Trading
Trading works on the simple concept of demand and supply. This concept by itself can be a stimulant for stock cycles. Here is a familiar scenario –
A trader buys a stock. The act of buying the stock increases its price. The increase in price attracts other buyers which further leads to increase in price. This goes on and on until somebody decides to sell. One person selling leads to reduced prices which leads to more panic selling which reduces the price even further. People who get left behind lose money and people who sell at the correct time come out as gainers.
This leads to a cycle of price increase and price decrease constantly and this happens in every single stock every single day.
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3. Debt
Debt is one of the main cause of cycles in the market. The meaning of debt is simple – You borrow money from your future self! Taking a loan allows a person or a company to spend more now but this will lead to reduced spending in the future. A person or company can keep on taking bigger and bigger loans to buy more (assets or liabilities) but somewhere down the line those loans have to be repaid to the lender. This means more current growth at the expense of future growth which is a textbook definition of a cycle.
4. Other assets
Stock Market is cyclical because everything in our world is interconnected. Rising prices of steel will be a good thing for steel making companies but a nightmare for automobile industry. Increase in Crude Oil will be a good news for oil-producing companies but a bad news for paint industry who uses Crude Oil as a raw material. Anything which happens in our world will be good news for one company and bad news for another. Even the recent coronavirus pandemic which was bad for most companies proved to be a blessing for hospitals, pharma companies, IT companies, etc.
And since the total money supply in the world is finite, the same money which is liquidated by selling a company from a downtrend sector is used to buy a company from an uptrend sector. The same money rotates from one sector to another, one asset class to another asset class and from one country to another country. This rotation of money between the assets leads to cyclical nature of all assets.
Stock cycles occur on a short term basis (minutely, hourly, daily) and on a long term basis (weekly, monthly, yearly) every single day. One particular stock might be starting a new multi-year bull run whereas another stock might be going into a bear phase for the next few weeks. The goal of any stock investor should be to identify the cycle of the stock and act accordingly to make good profits!
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