Stock Market Behaviour: What’s up with Wall Street?

I still remember the interview that I watched on TV3’s Ringgit Sense a while back involving our second Finance Minister, Tan Sri Nor Mohamed Yakcop. According to him, speaking of international trade, we are relying less and less on the United States of America. This was when he was questioned about the impact on Malaysia if the US goes into a recession.

However, as we have seen up until today, we are still being affected by what has happened in Wall Street overnight, stock market-wise of course. So, what’s up with that? Generally, if the Dow Jones declines, it will somehow influence the direction of the local market the next day.

Now, based on my limited knowledge, I shall try to explain this peculiar occurrence.

First of all, we need to understand that the stock market is not driven by economic data, or any fundamental data for that matter. This is especially true in the short-term.

The key driver of the stock market direction is this thing called human perception. As we all know, market participants are people. As such, it is only appropriate to understand that human psychology and sentiments steer the market.

Having an economy that is less dependent on the economic superpower, United States of America is good but it might take a while for this little fact to register in the heads of stock market participants.

Also, take this into consideration. Imagine that there are only 10 participants in a market. All of them do not know what the others are planning to do. You might think that you’re the only person who knows that the the US economy is not affecting our local economy at all, fundamentally speaking. So, to you, you will not overreact. Take note again that you do not know what the others are thinking. So, you might think that you are dealing with 9 others who are dumb enough (even though they are not dumb) to still believe that the US economy still affects us. Assuming the US market declines last night, logically, the pressure on our market to drop today is also pretty high (you’re assuming that everybody else wants to sell). If you do not sell, then you’ll lose money. So, your decision would be to follow the market herd and act in line with the assumed market sentiment.

So, even all of that 10 traders know that we are no longer affected by the US economy, but believed that the others are thinking otherwise, believe it or not, your decision will be based upon that assumption.

Now, imagine the stock market with thousands, if not millions of participants. All with different backgrounds and beliefs. Some are investors, some are traders. Some act based on fundamental analysis, some technical analysis. Some even act on rumours and tips. There are also the speculators, and gamblers.

That’s why in reality, the stock market is inefficient. That’s also why there are opinions going around that pure economists can’t be amazing stock traders. Study of the stock market is the study of human behaviour rather than the study of economics.

All right folks, as usual, any comments or rebuttals, write away in the comments section below.

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