4 Reasons Markets Move & How You Use It

Market Efficiency

Markets are designed to be as efficient as possible, so that the price is reflective of the underlying asset at that particular time. When an asset falls out of line with its perceived true value, the market, being the people operating in and trading the market, looks to rebalance the pricing to reflect true value. 

Market efficiency is enhanced by traders looking for opportunities where the market is not currently priced at true value, and by means of seeking profit by trading the market to true value, they inherently remove the inefficiency and thus help to create an efficient market. 

Opportunities exist particularly when a market is inefficient. Given that profit is available for those looking to take advantage of this inefficiency, the market is then shifted back to an efficient state and the trader is effectively rewarded for this observation when they put money behind their viewpoint. 

 

Balance of Orders

Orders going in and adding strength, orders going out and creating weakness. When orders in a particular direction are no longer coming through at the market rate, the market looks further up or down the price ladder to see the next point of value. 

If unlimited orders were at a set market value, the market would not move. Since people are not always willing to trade at the current market price, this means orders are placed up and down the pricing scale. Here’s an example of what happens when a market’s orders are out of balance:

Example: There are some orders at market, however there are 100 more orders wanting to be filled short. The next orders that can be used are below market price, and to fill 100 orders for a client, the institution needs to execute immediately, with the last of the 100 limit orders in the market being 20 points down. The execution takes place and the market inherently drops 20 points to where the 100th order is filled. 

In the above example, filling orders requires an opposing side to be ready to transact at a set price. If there are no orders waiting, the market needs to either wait for more traders to enter the market at that price, or accept a different price to trade at. 

 

Value Investment

Markets operate based on value, relative to other assets around the globe. Since markets are accessible globally and electronically, value is now on a much more global scale. If one market is greatly overvalued, while another asset is likely to perform far better over the period, traders are more likely to take positions in the asset with more value.

Take an index for example, if an index market is running out of steam and seems to have less value, less traders will be buying and perhaps more will be looking to exit that market or even short the market. This will also mean that traders and investors looking for value are likely to look to other markets for opportunity. 

This allows the overvalued market to resettle lower and become in line with global values once again. 

The term ‘value’ can be a tricky one, but when markets are in a bubble and there are very few people believing price can go higher, the bubble could pop and the value will be allowed to resettle to a point where the market is happy to trade at the new pricing.  

 

Human Psychology

While market efficiency is a concept that is true, human psychology can play a big part in trading. This concept can greatly shift the efficiency of the market as fear and greed sets in to traders. When a market rallies greatly, traders may look to enter positions higher and higher which can create potential opportunities for those who know the true value of the market and can ride out the wave of greed until the market turns around. 

Human psychology and emotions play a big part in creating opportunities in the market, along with irrational trading behaviour. This behaviour can help to create opportunities in the market, and traders looking for these particular movements can then rebalance the market and seek to earn from bringing efficiency back into the market.

 

How Use Market Inefficiency 

Understanding a market’s value, normal movements and also what behaviours to look out for, including overbuying and overselling, can help traders define the opportunities they wish to take and where the best value is in the market at that time. 

Helping to keep a market in balance, using knowledge of its true value can help a trader become successful.