Principles of Market Price Movements

Riding the "market train" through peaks and valleys:

  1. As a market reaches new lows, the value investors climb aboard. They buy up the available supply causing the decline to slow down, stop, and eventually to reverse.
  2. Once prices start to rise, more people start to buy. As price heads up hill in earnest, the momentum investors get on. Somewhere in here the stock reaches its actual fair value, but by now its climbing fast enough that the general crowd is jumping on board, driving prices up even faster.
  3. As prices reach really high levels, the hold outs can't stand it any more and they jump on, too. These people don't understand the markets and they don't have any plan. They just can't stand to miss out on this “sure thing”.

It's about this time that the value investors are looking at their PE ratios and other factors and deciding it's time to get out. As they start getting off the train, the increased supply of shares for sale causes prices to slow, then stop advancing.

  1. As price advances slow to a halt, the short-term traders get off. Then the momentum investors get off, too. The large number of shares for sale causes prices to start heading down.
  2. At this point the general crowd is getting out and looking for something more interesting. The glut of shares for sale makes prices fall even faster, zipping right past the security’s “fair market value”.
  3. As the stock reaches painfully low prices, the hold outs who bought in at the top are once again in a position where they just can't stand it anymore. They jump off the train near the lowest point, often selling out to the value investors who are now ready to climb back on board.

Points A and F are the same place. These cycles can be found on many different time scales.

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