Market Psychology Cycle: The Key To Successful Investing
Market Psychology Cycle: The Key To Successful Investing

Market Psychology Cycle: The Key To Successful Investing

Market Psychology Cycle: The Key To Successful Investing

The greatest ignorance is to reject something you know nothing about

Derek Bok Quotes

Market Psychology Cycle & The Markets

Contrarians only take a position that is contrary to the masses, and that wraps up the ideology of being a contrarian, well as far as most contrarians go today. Very few of today’s contrarians are true contrarians; they fall under the category of fashion contrarians.

Investors that adopt the doctrine of mass psychology correctly look for something more. Mass psychology takes the principle of contrarian investing and then pushes it to the next level.  Students of Mass Psychology look for extreme type situations. In other words, sentiment should not just be bullish before an opposing strategy is put into play, it should be at the boiling point and only then will the student of mass psychology look for an exit and attempt to take an opposing position to that of the masses. To illustrate this point we will use the following example.

Commodities and Gold

The commodities sector has several components, two of which are Gold and Silver. Throughout 2002 and early 2003, the hate and disgust for both these areas were extremely high. Fast forward to 2004 and Gold was being mentioned everywhere; even CNBC had a little Gold ticker that stated what the price of Gold was throughout the day. The hate or disgust for both these sectors was no longer there and even though both these sectors have a long way to go before the masses fully embrace them, they did not provide a psychological basis for taking an opposing position to that of the masses in  2004.

Gold went on to soar to untold heights that most would have deemed impossible in 2003. All along the way we continually stated that Gold would continue to trade higher and higher until 2011. Here are two of many articles that highlight this viewpoint article 1 and article 2.  We also warned our subscribers to bail out of Gold very close to the top.

Market Psychology Cycle vs the Mass Mindset

Even though the masses have not fully embraced Gold, this concept does not matter in the long run. A more critical criterion would be to find out what % of investors have taken positions in these sectors or not. Next, one would try to find out what the Gold bugs (the most bullish individuals ever created on earth) are doing. If all the Gold bugs are bullish, then based on the contrarian rules of investing you should take a contrary to a neutral position because all the individuals in your group are now bullish.

A very important criterion to remember also in terms of precious metals is whether should one really care what the masses are doing that much or focus on the Gold bugs (the group) that really care about Gold with passion.  The masses, in general, will not embrace Gold fully until it becomes fashionable and by then a significant portion of the Bull Run will be a thing of the past. In the last Gold Bull Run, the masses did not even know what was going on, let alone take a position in this sector. So one measure would be to determine if all the people who believe in Gold have already taken classes if they have then the market has become saturated.

Can Gold Trend To New Highs?

The only way it can continue its upward run is for momentum players to jump on the bandwagon.  These players have very short time spans of concentration and thus they jump in and out very fast. Once they decide to bail out, the corrective phase could be very painful as was the case of precious metals topped out in 2011.  The housing collapse and internet bubble are stark reminders of what happens once momentum has run its course.

Mass psychology is the constant analysis of the playing field to determine how the game is being played. Are the rules changing, are the players become more aggressive or docile? Is the playing field soft, rocky or worse yet, on extraordinarily high and treacherous ground?  One has to take measures at different levels and then compare it to the pattern you have already established from past observations.  In this sense, mass psychology is dynamic compared to most contrarians’ methodology.


Market Psychology Cycle  and Contrarian Investing

Contrarians do not measure their position relative to those of other contrarians; they only measure their work relative to that of the masses, and therefore they fail to obtain a vital piece of data.  This usually results in pain, misery and taking on substantial losses.  Look at the Gold bugs, they moved from the Euphoric phase, the having found religion phase, to the gnashing of teeth and pure misery phase, as they watched Gold plunge from the 1800 range down to the 1000 range.  They still cannot fathom why this happened, especially in light of the fact that trillions of more dollars have been created since 2011.

The Internet boom lasted a year longer after all the Technical Analysis (TA) and contrarian indicators were in the highly bearish zones. Euphoria for this sector was running sky-high and if one had simply used contrarian indicators and shorted the market, one would have been blown out of the water into the frying pan and roasted alive.  The same held true for the Gold bugs; instead of banking some profits, they continued to plough more money into Gold, and as it pulled back they jumped in joy and added even more. Once the correction moved from the mild to the wild phase, they panicked and started to pray. Today the sentiment is almost as bearish as it was in 2003. So a great buying opportunity is at hand.

Mass psychology involves work, while contrarian investing involves very little; other than taking a position that is opposite to the masses, very little effort is needed. We are now speaking of the biggest class of contrarians (fashion contrarians). Therefore most pure contrarians were caught flat-footed when the Equity markets mounted this massive rally from Oct 2004. Their contrarian indicators suggested shorting the market or taking a neutral position was the right thing to do.

Market psychology Cycles: 90% of Investors will lose

No matter what people do, only 10% of the investors can win at any given time. The moment the crowd starts winning, no matter what side of the fence they are on, contrarian or the masses side; the markets will adjust to bring this ratio back to its norm.

This is a vast subject, and we could write pages on it; we have, so please just enter the search term “contrarian or mass psychology in the top right corner of the page to find more articles on this topic.

Most contrarians are fashion contrarians; in that aspect, they are no different from the masses. They embrace a position because it appears to be fashionable, and when something goes wrong, they panic.  All you need to remember is when the masses are euphoric, it’s time to panic and vice versa.

Inductive Thinking and Psychology

Investing based on psychology amounts to not only taking a position against the masses but against the actual fashion contrarians once sentiment has reached the boiling point, or at the very least, taking a neutral position. Less attention is being paid to the Gold and Silver sectors and both are becoming good investments from a contrarian and a Mass Psychology perspective.  Mass Psychology and Inductive thinking are related; more on this topic here. Inductive vs Deductive reasoning- for investing in the markets

Now that Gold has almost broken below 1100, religion is being abandoned and the wailing and gnashing of teeth phase is taking hold, as the Gold bugs are literally decimated; all their prayers have gone unanswered and despair is setting in.   They cannot fathom how with trillions of more dollars being printed, Gold instead of soaring continues to get hammered. Again, we need to repeat the phrase we recently used…….. “Welcome to my lair said the spider to the fly… to which the fly responded which one”…    We have two worlds coexisting together, the illusory and the real. Most have embraced the illusory so the illusory supersedes reality for now, and this is what the Gold bugs do not fathom.   The masses actually believe money is created from trees in contrast to sweat and labour and so until they think otherwise, the Fed can continue running the press, and the masses will be none the wiser.   Market Update July 31, 2015

Gold stocks have been hammered, and blood is flowing in the streets, so the astute investors should be slowly adding to their positions. We used the profits we locked in when we got out of Gold to open some positions but are waiting for a significant buy signal from our Trend indicator before we back the truck up.

Do or be done in…… Sol Palha


Other Articles of Interest

Why market crashes are buying opportunities

Stock Market Corrections-Nothing but Buying Opportunities

Markets; time to dance or Drop