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What is Market Psychology?

Jacob Queen
Jacob Queen

Market psychology is a term used in the world of high finance to describe the investing behavior of the masses. The general concept of market psychology is related to efficiency. In theory, if people always behaved logically, the market and the economy would always make rational sense in relation to each other. In reality, people don’t always behave rationally, and often their actions have more to do with emotion than any logical motivations.

Sometimes market psychology has good reasoning behind it. For example, if traders see the economy falter, they will often become reluctant to trade, and the investment markets will turn sour. At other times, things that are totally unrelated to finance can send the market into a sudden dive or climb. For example, an international incident that makes people fear a possible war may not have any immediate financial impact, but it can potentially make investors reluctant to trade anyway.

Man climbing a rope
Man climbing a rope

Investors have developed many methods to try and measure market psychology, but it can be one of the more difficult aspects of the market to predict. Even the best market experts often make errors when trying to make decisions based on the expected market psychology in a given situation. Sometimes the mood of the market is obvious and easy to gauge, but when the situation gets more complicated, there are often too many chaotic elements affecting the mass mood of traders. In those situations, the market can do things that make no sense, and experts may not be able to say for sure why things happened, even after the fact.

Sometimes market psychology can lead to chain reactions. One group of people may become upset or excited about some small thing, and this emotional intensity can spread. Essentially, when the market starts going down, it’s common for the entire market to be affected, even if the initial occurrence is only related to a single market sector or one tiny piece of news.

The news media has had a significant impact on market psychology. In the early days of the market, news was generally harder to come by, and it took longer to get news after something happened. The advent of 24-hour news channels has made market psychology more dynamic. News is able to spread more quickly, and it can spread at all hours. This means that the market psychology can become more erratic, with less noticeable provocation for many actions and more overall complexity.

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