Recently, I have explained the similarities between our minds and the financial market. Both are complex systems affected by emotion and rationality. That complexity often makes it hard to predict those behaviors, especially during a confusing period.
Today, I will talk about the logic of the price collapse in the financial market. This knowledge allows us to understand the strange behavior of our minds or the price movements in the financial market.
How to predict future behavior
Sometimes, we want to know why it behaves the way it does. We are reassured when we can predict the behavior. If not, we often feel, “Why do you behave like that?” That makes us want to know the reason behind it.
Perhaps that is because the more we can control our resources, the more we can use them efficiently. In other words, we can use them as assets that could turn into value in the future.
Typical examples are our minds and the financial market. If we use them efficiently, they will be our assets.
However, we sometimes don’t know why they behave like that. That prevents us from living as we are or creating wealth through investment.
Today, I will explain how people’s greed causes the financial market to collapse. This knowledge might allow us to understand our complex minds and the strange price movements of the financial market.
The logic behind the financial market collapse
In the financial market, there is a phenomenon called a bubble economy. It is a state in which many people believe the economy or prices will go up forever without falling.
That causes the price to collapse. The reason is simple. People’s greed causes it.
In such a situation, some people go into debt to invest. In financial terms, they call it leverage. We can increase profits with it.
That makes some people go crazy. They borrow money and invest it with as much leverage as possible. The more the economy overheats, the more people tend to do so.
An example of the real estate market
A prime example is the real estate market. Real estate and housing markets are the easiest to borrow money from banks.
During the price rise, they keep borrowing and buying even if it is at an all-time high. Big articles on the Internet or SNSs say,
“The housing prices have skyrocketed! They won’t stop. Many people are rushing to buy. If you miss buying now, the good ones will run out soon. Buy now!”
However, there could always be a price drop, more or less. In addition, people with debt must pay the interest payments.
The chain of selling
That triggers a chain of selling. When the price drops, the most leveraged person must sell one or several houses to pay interest payments. That selling causes a little more price to fall. That makes the second-most leveraged person sell his real estate to pay off his debts. That creates another price drop. It affects the third-most leveraged person.
The price of real estate suddenly starts to drop. Some people judge based on rationality, assume it is affordable, and buy it.
However, the price keeps falling due to the leverage. Leveraging has such destructive power.
Then, people who used to be driven by rationality will be moved by emotions. They come to fear losses. There are big and shocking articles on the Internet or SNSs,
“The housing price decline won’t stop! They won’t stop! Many people are rushing to sell. If you miss selling now, opportunities to sell will run out soon. Sell now to prevent losses!”
The rational phase ends, and the emotional phase begins. People sell emotionally driven by fear, even if it is the cheapest. They buy high and sell low.
That is the logic behind the losses.
How to deal with a complex system with cycles
A bigger picture of the cycle tells us how to deal with it.
We can act according to where we are in the cycle. If it is already night, we can understand that we are ready to go to bed, even if many people start fussing. The financial market is the same. If it is at the end of the bubble economy, we can withdraw from investing in stocks, even if many people actively start investing.
The housing market bubble occurs at the end of the bubble economy because it is the easiest market to borrow money from banks.
That allows us to predict the future. According to my logic, the stock market’s peak will be around this July or August, although there may be a delay.
Prioritizing our phase of cycles over our wishes
In other words, we prioritize our phase of cycles over our wishes. Greed and awareness of the cycle are incompatible. An understanding of the cycle allows us to prepare for the downturns. That makes us humble and gives us the best performance.
We cannot control the cycle of a complex system, such as our minds and the financial markets. We cannot avoid going to bed at night if we live naturally. Going against the waves makes us lose a sense of control over our lives.
We can learn about the cycle from history. That may give us a stable mind and benefits.
Conclusion
That is why people’s greed causes the financial market to collapse.
A bigger picture of the cycle tells us how to deal with it. That makes us humble and gives us the best performance.
This knowledge might allow us to understand and adapt to our complex minds and the strange price movements of the financial market.
Thank you for reading this article. I hope to see you in the next one.
