For those who observe it from the outside, perhaps as a layman,
online trading is a sort of mystery. What instills a certain reverential fear, which in most cases is
enough on its own to discourage access, are in truth the market oscillations: too deep, inexplicable. If the idea of living on perpetual roller coasters doesn't generate particular feelings in experienced traders, it generates feelings of fear and confusion in beginners and external observers.
Yet, it's all more understandable than one might imagine. In some ways, even predictable. Maybe not in terms of timing (and this alone is enough to catch even the most experienced off guard), but in terms of how it works, yes. This is true because, ultimately, the market follows certain models, and the oscillations are explained fairly well by these models. In the following article, we present a very effective one as it is quite detailed. To do this, we will refer to
an interesting article by Gianluca Defendi of Class CNBC, published on June 17, 2020 on MilanoFinanza.
It's a useful model always and in any case because it not only explains how the market behaves, but also helps to understand which phase it is going through at the moment. A strong need, that of understanding the present, especially in an uncertain period like this one.
But let's proceed in order. As you can see from the photo, the model represents an oscillating curve with a maximum and a minimum. The curve is divided into segments, where each segment represents a phase. It can be divided into two huge sections, one pointing to the
market top and one pointing to the
market bottom.
Towards the Market Top
The model starts from an arbitrary point. Obviously, the curve is meant to be continuous, infinite, but Defendi has set the beginning in an "optimistic" market phase, therefore one of balanced growth. In this phase, investors are confident that the market will rise, thus opening long positions.
Then, once investors realize that the positive trend shows no signs of slowing down, the excitement phase emerges, where more and more operators enter the market in the hope of participating in the rally banquet. At this point, excitement turns into exaltation, and exaltation into euphoria: prices rise and volumes increase. We reach a condition of overbought and hit a high.
Towards the Market Bottom
At this point, things start to change. They do so for two reasons. One, psychological, conceals a certain awareness that "it can't continue like this," that it's all "too good to be true." The other, of a technical nature, is given by the desire of an increasing number of investors to cash in. Therefore, short positions and sales also increase.
Hence, the price begins to fall. At first, there is a certain anxiety, as the near future of the asset appears uncertain: will a negative trend be established? When prices start to seriously fall, we enter the denial phase: many investors want to believe that the declines are actually retracements, and that an upward trend will soon return.
However, hopes are dashed and the downtrend shows itself in all its solidity. The pessimism phase emerges, in which short positions start to accelerate more and more. Then, something happens, investors start to get scared, fearing the duration of the declines, and overselling is unleashed. It's a kind of descent into hell in which tension, fear, and finally panic follow one another. The result is a low, which can be more or less deep, and which reveals a condition of discouragement.
The Return to Optimism
As always in these cases, once the bottom is hit, we rise again. Also because in this phase, with prices very low, investors start buying (simply because it's convenient). The subsequent phases are marked by distrust, but then hope emerges, then confidence, and finally optimism, with an increasingly larger share of long positions compared to short ones, with an increasingly solid and steady increase in prices.
Thus, we return to the phase that opened the model, and the cycle continues.
Does This Model Always Work?
This is an interesting model, which if it doesn't explain the reasons, at least illustrates the various phases, freeing the trader from the unpleasant feeling of not knowing where the market is taking him. The causes, however, are still a mix between psychology and technique: prices fall because investors start selling, and they start selling both to cash in and because they are fearful for the future.
One has to wonder if this model always works in all cases. Actually, being a model, therefore an abstraction, it may not always be adherent to real life. However,
it is quite faithful to what happens continuously in the market.
Above all, it explains the movements
both in the medium and short term. If you apply an overview with a three- or four-year horizon and a wide timeframe, the model works quite well. But it also works well to explain sudden highs and lows, rapid stock market crashes, and relative recoveries. An example is given precisely by this period, which has seen sensational lows and significant recoveries, apparently unjustified given the ongoing health emergency, but explained very well by the model.
A Piece of Advice for Investors
How can an investor active in online trading exploit this model to their advantage? Mainly, by using it as psychological support. The model, in fact, comforts those who trade online because even in the darkest hour, it foresees a recovery. At the same time, it puts the brakes on, invites balance when things seem to be going too well.
The advice, therefore, is to
use the model to understand which phase the market is in, both from a "broad" observation perspective, which embraces a couple of years, and from a "narrow" observation perspective, which takes into account reactions to an adverse event. In short, the model is a bit of an orientation, a map to move in a terrain that would otherwise be unknown and full of pitfalls, more than it
naturally is, due to its very structure.
