Principles of Market Price Movements

The branch of mathematics known as complexity theory shows how the interaction of a large number of independent agents acting in their own interests can produce results that superficially appear to be random even though they are not. Rigorous analysis of the data shows that market price movements clearly are not simple random walk sequences[2] and markets have long-term persistence (memory)[3].

Why do markets trend? Because people are creatures of habit. Once they start doing something, people tend to continue doing it until they find something more interesting to do, or they decide that what they're doing is a bad idea. Furthermore, people pay attention to what others in their group (market) are doing. This is partly a financial phenomena (fighting the crowd can be dangerous to your wealth) and partly a sociological phenomena.

This combination of forces creates an effect that traders have long known. In the words of one market professional[4]:

You will probably not believe this now, but in about twenty years of investing you will come to live by this observation: Whatever a stock price is doing now, is most probably what it will be doing tomorrow, next week, and next month. If it is going up now, it most probably will be going up tomorrow, next week, and next month. If it is going down now, then its most probable course for the foreseeable future is probably down as well. If it can't make up its mind which way it wants to go, it will probably be just as confused when the sun comes up tomorrow.

Allan Harris

Knowing that markets trend can be useful, but there's always the nagging question: how long will the trend last? The answer is that the trend will last until there is a significant change in people's perception. Unfortunately, there is no way to tell when this will happen. Sometimes all it takes is a tiny event to change the way people see a given market. However, opinion does not generally change overnight - i.e., when a trend is over there's almost always time to get out if you recognize what is going on.

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