What Are Market Sentiment and Market Cycles?

Financial markets have what is known as a "psychological market cycle." This means the overall feelings investors and traders have about asset price movements move in a repeating cycle.

When prices rise, many people "cheer," and when prices fall, many people "despair." This creates feelings about "bull markets" and "bear markets," which in turn shape collective market sentiment.

Market sentiment is made up of the individual emotions of every investor and trader in the financial markets, so in the end it can be seen as the average of those emotions.

However, no single dominant sentiment lasts forever; it changes from moment to moment. Investors and traders should analyze both market sentiment and their own psychology and try to stay objective.

Market Sentiment and Cycles

📈 Market Sentiment in an Uptrend

In an uptrend, a mood of optimism, belief, and greed takes hold. Emotions and prices tend to feed off each other. As prices rise, investors become more positive, and this leads to more buying.

However, if excessive greed and belief continue, a bubble can form. Investors may then act irrationally, ignoring the market's real value and overbuying assets on the strength of the buying momentum.

Toward the end of an uptrend, an asset may gradually decline and then move sideways, but sometimes a sharp drop follows straight from the top without any sideways phase.

📉 Market Sentiment in a Downtrend

Even as the market reverses from an uptrend into a downtrend, most traders may stay complacent, thinking the uptrend isn't over yet.

Then, as prices keep falling, market sentiment starts to turn negative. Investors may begin to feel anxiety, denial, and fear.

Once anxiety sets in, investors start questioning why prices are falling, which soon leads to the denial stage. At this stage, many investors get caught up in thoughts like "it's too late to sell" or the belief that "the market will recover soon," and they try to hold on to losing positions.

If prices fall even further, selling pressure grows stronger. At this point fear becomes dominant, and this is called the "capitulation" stage. Holders give up and sell their assets at prices close to the bottom.

Finally, as volatility decreases and the market stabilizes, the downtrend comes to a halt, and the market goes through an accumulation stage, a sideways period, before hope and optimism return.

How Can You Use Market Sentiment?

By understanding and using market sentiment, investors can enter and exit positions at more favorable times.

The moment with the greatest profit potential is usually when most people are in despair and the market is deeply depressed. Conversely, the most dangerous moment is when most market participants feel euphoric and confident.

Traders and investors who understand market sentiment theory try to read the market's mood to identify the different stages of the psychological cycle. They consider strategies such as buying when there is panic (falling prices) and selling when there is greed (rising prices). In practice, however, pinpointing these optimal moments is never easy, because a support zone may fail to hold and break down.

So while you use market sentiment, you should always have your own trading risk management strategy ready and think ahead about ways to limit your losses.

About Cognitive Biases

Cognitive biases are thinking patterns that often lead us to make irrational decisions. Let's look at a few common examples.

1. Confirmation bias: The tendency to overvalue information that confirms your existing beliefs while ignoring or overlooking information that contradicts them. For example, an investor in a bull market may focus only on positive news and ignore bad news or signals that the market trend could reverse.
2. Loss aversion: The tendency to fear losses. The pain of a loss feels greater than the joy of a gain. Because of this, traders may miss good opportunities or panic sell during periods of high market volatility.
3. Endowment effect: The tendency to overvalue an asset simply because you own it. For example, an investor who holds Bitcoin may strongly believe that Bitcoin is the most valuable asset.

These cognitive biases affect investment decisions. That's why it's important for investors to overcome them by carrying out objective analysis and critically reviewing their own decisions.

Metacognition, the ability to accurately recognize your own biases before investing, is one of the most important skills for any investor or trader.

Final Thoughts

Both market sentiment and the psychology of individual investors are important factors that influence investment decisions. However, understanding and dealing with these psychological aspects is not easy.

Past financial crises and bubbles clearly show how psychological factors have affected markets. In cases such as the Dutch tulip mania and the dot-com bubble, collective euphoria and excessive optimism led to excessive price increases, which were later followed by enormous declines.

Understanding your own investment style and emotional tendencies can help you make better investment decisions. This process can take time, and you have to learn and grow through experience. It can be a great help for successful investing in the future.