When it comes to investing, it helps to go into it with a fairly sound understanding of what to expect. In this article, we’re talking about “the market.” How do you achieve every investor’s dream of buying low and selling high in a crowd of highly resourceful and competitive players? The answer is to play with the crowd rather than against it, by understanding how market pricing occurs.
The Market: A Working Definition
Technically, “the market” is a plural, not a singular place. There are markets for trading stocks, bonds, commodities, real estate, and more in the U.S. and around the globe. For this purpose, you can think of these markets as a single place, where opposing players are competing against one another to buy low and sell high. Granted, this “single place” is huge, representing an enormous crowd of participants who are individually and collectively helping to set fair prices every day.
The Business of Investing
With all the excitement over stocks and bonds and their ups and downs in headline news, there is a key concept that is often overlooked. Investment returns are compensation for providing the financial capital that feeds the human enterprise going on all around us, all the time. This is often referred to as the “Risk Premium” – the reward for taking the risk of investing.
When you buy a stock or a bond, your capital is ultimately put to hard work by businesses or agencies who expect to succeed at whatever it is they are doing — whether it’s growing oranges, running a hospital, or selling virtual cloud storage. You, in turn, are not giving your money away. You mean to receive your capital back, and then some.
In the investing world, the terms “bull” and “bear” are frequently used to refer to market conditions. These terms describe how stock markets are moving in general — that is, whether they are appreciating or depreciating in value. As an investor, the direction of the market is a major force that has a significant impact on your portfolio. Therefore, it’s important to understand how each of these market conditions may impact your investments.
- A bull market is a stock market that is on the rise
- A bear market exists in a stock market that is receding, and most stocks are declining in value
How does the market’s behavior affect your returns? It surprisingly has a lot to do with psychology.
The market’s behavior is impacted and determined by how individuals perceive and react to its behavior. Stock market performance and investor psychology (how investors view the market) are mutually dependent. In a bull market, investors willingly participate in the hope of obtaining a profit. During a bear market, the market perception is negative, resulting in investors moving their money out of equities and into fixed-income securities as they wait for a positive move in the stock market. The decline in stock market prices rattles investors, causing them to keep their money out of the market. This, in turn, causes a drop in share prices.
What Does it All Mean?
Both bear and bull markets will have a significant influence on your investments, so it’s a good idea to understand what the market is doing when making an investment decision. However, both terms are lagging terms that label what has occurred in the last. It is impossible to know if a bull or bear market will continue into the future while experiencing it in the present. Remember that investing is a long game. Every investor should consider their time horizon. The ability to maintain an investment strategy for a long period is one of the best indicators for potential success.
If you need help getting started with investing or are ready to take another look at your existing portfolio, we’d love to offer you guidance. Contact us today to start feeling more confident about your financial future.