From Bull to Bear: Why Stock, Futures and Forex Markets Correct

To understand this phenomenon, we must first look at how commodity cycles occur.

When commodity prices are high, there is an attraction to produce it, because the high prices offer high profits. When they are low, the opposite happens, because who wants to put all their money into producing a commodity if it is so cheap there is no profit to be had.

If we start at the bottom of the cycle, we’ll be able to understand this better.

Let’s create a commodity called ‘X’. X is a commodity that is used every day by people the world over. X is very cheap, at around $1 a parcel. Because it costs about $3 a parcel to grow, no one is producing it; however this doesn’t stop people consuming it. At this time there is a mound of X in Farmer Joe’s warehouse and so there’s no need to produce it either.

As months go by, the pile of X is stating to diminish, and so Farmer Joe who recognizes that the consumption of X is still constant starts to raise the price; which doesn’t seem to affect consumption all that much, because X is a necessity. After a few more months, Farmer Joe recognizes that he is able to sell X at $7 a parcel without any impact on consumption.

Farmer Joe sees this as an opportunity so he decides to plant some seeds and grow some more X. The only problem is it takes 12 months for X to mature, all the while the mound in his warehouse gets smaller and smaller, and the price at which he is able to sell keeps getting higher. In fact he is now able to fetch $12 a parcel.

Other Farmer’s around the area see what’s going on and decide they are going to grow some X too. Several months ago there was just a large mound of X and no X farms; now there is a small mound of X and plenty of X farms in production.

As Farmer Joe’s farm matures he is able to fetch a nice $12 a parcel for X, and so he is smiling, however not long afterwards, many of the other farms begin to mature also. All of a sudden there is a massive glut of X, which drives the price of X right down, back below $3 a parcel. The farmers who were last to grow X find that they will now have to face a loss.

In this situation, it was the farmers who created the cycle, and not the consumers; who just consume X, and pay what ever the price is on the day. However the price was dictated by the amount of X available, and this was due to the farmers. When there was plenty of X around, the price was low, and when there was very little around, the price was high; however it was the rush to produce more X that created the glut.

The fundamentals around X was simply supply and demand, and this supply and demand was created by the market participants themselves; the farmers.

All financial markets are the same. Investors and traders may go to many lengths to work out the fundamentals behind a stock or market, but the real driving force is the supply and demand equation, which is created by the market participants themselves.

If everyone on the planet is bullish and long on a market because the ‘fundamentals’ suggest that this market is sound, they have affected the supply and demand equation of this market irrespective of the fundamentals behind it. They have in fact created an energy that will force the market the other way, simply because there is no one left to push prices higher.

The same is true the other way. If everyone is bearish a market, irrespective of the fundamentals, they will effect the supply and demand equation to the point where there are simply no sellers left. Price will then head up; which will seem to contradict the fundamentals or news at that time.

To jump on a stock or market at the top is to buy when everyone else has bought. If you base an investment decision on information made available to everyone, i.e. the front page of a newspaper, you are in effect the last farmer to plant X seeds. The front page syndrome is the symptom that tells you the supply and demand equation has now turned around, regardless of the fundamentals.

We are in a precarious moment with regards to the markets currently. Where we go from here will be determined by the supply and demand equation with respect to the market participants. Are they all bearish, bullish or are they undecided? If they are all bearish, we can only go up; if they are all bullish, we can only go down.

If they are undecided, we get volatility, however all turning points in markets are created by an extreme in supply and demand of the market participants. All trends are the transferring of one to the other. In other words, when there is extreme bearishness, the market will head up, and keep heading up until all the bears turn into bulls.

Are you going to be the last farmer who plants his X seeds?