Market Corrections

I am neither pessimist nor optimist in my approach to broad market trends. I wont bore with the statistics and detailed historical data concerning corrections, but the fact is they happen as a natural part of market dynamics. What many fail to realize is that corrections occur in both directions. A market correction is simply the market trying to find its own balance, or level. As a mathematical process, a market has an equilibrium that is based in a “sum zero” format. The formula for this balance is based on valuations, earnings, pricing power, growth trends and profit. This model is used by economists, traders, investors and governments to forecast economic models for a variety of reasons. Without this baseline value, the market system wouldnt work, we would be at the mercy of a rudimentary barter system to fuel economies,companies and governments. Not good. Not good at all.

Now we factor in my favorite part of a mathematical market process.

Chaos. Gotta looovvveee that chaos.

In this model, chaos comes in the form of volatility. The whitecaps and troughs of our financial sea. Chaos is catalysed by several factors but the two most important are flip sides of a coin. Fear and greed.

Fear of loss.

Greed for more and more.

These two emotions account for nearly half of all market volatility but are equaled by my personal favorite market catylyst.

Ego.

Ego has created legends and broken kings. Often the same person wore both mantels at different times. While the market is not a living organism itself, its parts are. Ego is the one emotion that even the baseline model adherents fall prey to. While you and I are allowed to trade on fear and greed, the true market shapers are not. They trade on the model forecasts. Period. Icahn probably cant spell candlestick. Soros doesnt care what last months volume was. Their time horizon is far to long and their bets are far to large to risk on a five day trend. They only care what the model does. When the trend is in line with the model, they stay and often add to their holdings, thus perpetuating the trend and the model.

When the model begins to break down, I.E. some catalyst unexpectedly occurs that drasticly alters a component of the model such as a major spike in fuel costs, they begin to look at the updated model and then they re-allocate their portfolio accordingly. This isnt done very often, moving billions and billions of dollars worth of securities from one sector to another has problems of its own, and can alter the model itself, which creates yet another problem.