Question

Some people argue that the reason financial markets follow a chaotic pattern is because of the psychology of traders. Discuss the following statement from Warren Buffett, who actually borrowed the quote from Benjamin Graham:

"The market behaves as if it were a fellow named Mr. Market, a man with incurable emotional problems. At times, he feels euphoric and can see only the favorable factors. At other times, he is depressed and can see nothing but trouble ahead for both the business and the world."

Is Mr. Market necessarily predictable (e.g. can we predict market mood swings by using technical indicators)?

Answer 1

Market does behave in an irrational way in the short -term. It is often seen that stock prices fall even when the earnings of the company are rising and stable so a lot of things in the market is dependent on the psychology of traders for the intra-day movement because price will move depending on the demand and supply of the stock. However, in the long run the stock price hover around its intrinsic value and there is high probability that the stock price would be less volatile. This behavior is often seen in the index also, which is often seen as a behavior of the market. We can use technical analysis for predicting the movement of the market by using certain technical indicator but these indicators are also more appropriate when they are used on a daily basis or weekly basis because intra-day the price is so volatile that the probability of getting wrong buy or sell signals would be high and every time you are wrong you incur loss. These indicators are useful for the long-term when used in combination with fundamental analysis. They can provide good entry and exit points but some traders use technical analysis for intra-day trading also.