How does the law of supply and demand and emotional investors affect market volatility?

How does the law of supply and demand and emotional investors affect market volatility?

Posted on August 10, 2011

August 10, 2011

About two weeks ago, the markets were kind of boring. Today, it feels like we are in a bungee market. So what drives the market's movements? Is it an event like the U.S. Treasury down grade? Is it the foreign debt crisis? Is it the Federal Reserve? The markets are driven by one thing and one thing only, the Law of Supply and Demand.

The Law of Supply and Demand is driven by investors actions based on what they believe and how emotional they are about their beliefs. The only way a market, any market, can go up is by having more investors initiate buys than sells and vice versa.

Investors vacillate between two extremes, the “intelligence of crowds” and the “madness of crowds.” We see the intelligence of crowds when the collective knowledge of “rational investors” comes together as buyers and sellers. The actions of rational investors result in “efficient market pricing.” On the other hand, the “madness of crowds” occurs when high emotion takes over. Emotional investors cause volatility by acting in the same way at the same time. The effects of emotional crowds are inefficient market pricing, bubbles and busts.

Today, communications technology is making it possible for almost anyone to have immediate and unprecedented access to global information. Most of the time, access to information leads to more collective knowledge and should result in more efficient market pricing. Unfortunately, sometimes immediate access to large amounts of information can create confusion leading to high emotion and volatility caused by the madness of crowds.

Successful portfolio management requires a dynamic process and the ability to adapt to rational and emotional market environments.

So, what should we do now to deal with the current volatile market? Please read Part 2 of this week’s blog.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in portfolio and risk management.