Lab Summaries - Bull Market Rhymes

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When I first started investing, I assumed that fundamentals and such were the key factors in driving market prices.

But this is only part of the equation.

Understanding the psychological factors that drive market movements is vital in making informed investment decisions.

During this bear market, this is perhaps the best time to learn and recognizing the patterns and biases that shape market behavior.

When market sentiments reverse in future, investors like you and me can then gain a better understanding of the market's underlying dynamics and make better decisions.

Here's a gem of an memo by Oak Tree Capital that you should absolutely give a full read.

To give you a hand, I've also given the full memo a read and consolidated my key takeaways below. Enjoy!

Why do we have market cycles?

Market cycles are largely a result of Excesses and Corrections, amplified by investor psychology.

When investors are bullish, they tend to be overly optimistic. Stock prices soar well above fair value as a result.

When the elevated prices become clear, and conditions in the investment environment disappoint, prices fall back towards fair value.

This creates further pessimism, and causes prices to far understate the value of stocks.

Correction occurs when buying from bargain-hunters causes the depressed prices to recover toward fair value.

Features of bull market psychology

Bull market psychology is characterized by a positive outlook, aggressive behavior, and a tendency towards increased risk-taking.

As stock/crypto prices rise, investors become increasingly optimistic, leading to an upward spiral of buying activity.

This positive psychology is the driving force behind bull markets.

As investors take the rising prices as positive signs of things to come, they continue to make bullish bets on the future, further driving up stock prices.

Stages of bull markets

Bull markets can be largely split into 3 stages:

• First, when a few forward-looking people begin to believe things will get better,

• Second, when most investors realize improvement is actually underway, and

• Third, when everyone concludes that things will get better forever.

How investor psychology affects asset prices

We might assume that asset prices are solely a measure of fundamental developments. This might only be partially true.

This is because in investing, perception plays a key role. Perception of assets often swing drastically - from 'flawless' to 'hopeless.'

We often see positive or negative fundamental developments pile up for a good while, with no reaction on the part of security prices.

When a tipping point is eventually reached - either fundamental or psychological - the whole pile can suddenly get reflected in prices, sometimes to an excessive degree.

The price of an asset is thus based on 2 factors: (a) Fundamentals and (b) How people view those fundamentals.

Therefore, the change in an asset price is based on a change in fundamentals and/or a change in how people view those fundamentals.

Main takeaways

These investment themes are largely psychological, and the way psychology works is unlikely to change.

Hence, as long as humans are involved in the investment process, we'll see them recur time and time again.

As such, since market swings are primarily driven by psychology, market movements can only be predicted when prices are at absurd highs or lows.

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