Three Reasons That Markets Correct

With some healthy volatility returning to the markets, I've seen lots of commentaries speculating on the reasons for this correction.  I thought it would be helpful to remind everyone that there are exactly three reasons why markets correct.  

1) Markets don't move in straight lines.

With the recent period of low volatility and a steady uptrend, we have all become very comfortable with a slow and steady increase in prices.  Unfortunately, this is actually highly unusual. 

As Elliott Wave Theory postulates, markets move in a series of impulsive waves and corrective waves.  While I don't use Elliott Wave in my analysis, I do believe that it's a fantastic illustration of the behavioral characteristics of different phases of a bull market.

2) Euphoria and Panic are driven by the same emotion: Fear.

Earlier in my career, I used to say that markets were driven by fear and greed.  These days I say that markets are driven by fear alone.  In a bull market, fear of missing out; in a bear market, fear of losing everything.

On CNBC this week, Jeremy Siegel shared the famous quote, "Markets go up the staircase and down the elevator."  

Make no mistake, at some point during the uptrend of recent years, fear of missing out fueled additional buying.  And fear can turn on a dime, quickly turning into panic.

3) Markets go down because there are more sellers than buyers.

We want to believe that market movements need a reason.  The Fed.  The yield curve.  Geopolitical issues.  Inflation fears.  Something.

As I always taught my students, price goes down for one simple reason.  There are more sellers than buyers. 

So regardless of the underlying causes for the buying and selling, you need to incorporate a toolkit that helps you see when buyers or sellers are dominating the tape.

Don't get me wrong- over the long-term, markets trade to the fundamentals.  But over the short-term, the market is often driven by fear.


Disclaimer: This blog is for educational purposes only, and should not be construed as financial advice.  Please see the Disclaimer page for full details.