By Andrew Wong     11rd Oct.2001

Stock Market & Systems Thinking


This article is inspired by a seminar on Systems Thinking, whereby various Systems Archetypes are explained with drawing of Casual Loop Diagrams of key variables affecting or driving certain pattern of behavior.

As stock market behavior, to a large extend, is a manifestation of market players' behavior or sentiment, the Systems Thinking tool is applied to better understand the market forces and movement.

With such understand, we can better design strategies to benefit from the market.


Iceberg Theory 

Iceberg Theory is a useful model to understand where and how Systems Thinking can take shape in our day to day living. Essentially it says that what is above the water level is called Events, some things we see or observe easily. Over time, these events form certain patterns and trend, IF we care to examine closely, or go deeper down the water level. Iceberg theory says that there is another deepest level of "things" called "Structures" which really drive the pattern of behavior, giving rise to the various events or symptoms that we easily observe or see.

Hence to better understand why the phenomena or situation, we need to acquire the discipline of going deeper down the iceberg to "see" or understand the structures, which are the fundamental drivers. Otherwise, we tend to be REACTIVE when encountered with Events. Our response becomes better if we can see the Pattern, as we tend to adapt or anticipate. We become wiser, if we can "see" the Structure as we can be Generative or Creative.


Stock Market and Iceberg 

In stock market, every day we are bombarded with events : news reporting market movement or performance of the day, say, index rises or falls, sometime they give logical explanation to event e.g. US economy is facing a downturn (US bombed! causing massive downfall of the market), interest rate up (or down), un-employment rate up or down. Hence an event is explained by a logical reasoning on isolated or discrete cases. Investors or market players usually REACT to the market events : "market is falling, I must buy more" or, "Market is falling, I must quickly sell" etc. etc.

However careful observer or skillful investors or market players observe that  market movement has certain pattern and trends. The wiser one will realize : "Market will not fall forever, nor, will market rise forever" "There is certain time, market is low enough for investment, certain time, market is matured to take profit". Other time, irrespective to whatever events, stay away from the market.

As an analogy, take for example the pattern of day-and-night in tropical country, about 6-7 a.m. sun rises, 6-7 p.m. sun sets. We do not explain "Today the sun rises at 6.30 a.m. because more forests are destroyed" or whatever logical explanation, we either adapt or anticipate day after day, sun rises and sun sets in the range of time. It is because we understand the pattern of behavior.


Understand the Structures that cause Market Behavior

To understand or see the Structures that drive the pattern of market behavior, we need to identify some key variables. We have to be careful not to choose the many variables at the events level, as the Iceberg theory says that there is not only little leverage, we get clouded by many trivial issues. The author chooses the following variables : a) Price, b) Sentiment, c) Perception of Economy d) Trading activity. When the perception economy is good for more potential growth, Investors engage in trading (buying) activity, which drives the price up and creating positive market sentiment to attract more players. Hence we have a Reinforcing Loop formed. The reverse is true for downtrend of the market. Hence this simple structure explains either the uptrend market or downtrend market, i.e. Reinforcing Structure. If we accept this as the basic structures that drive the market up and up, or down or down, then we should NOT be concerned with whatever may be the "seemingly logical explanation of the events, as reported by the news or the rumors".

Human nature is such that we are REACTIVE at event level. We ignore the Pattern and Trend behavior.

Do you want proof? 

Well, look back at the peak of the bull market, weren't there plenty of good news in the mass media and rumor that drives many to buy more at high prices. Then market turned downward, causing much regret and suffering. Likewise, at the very bottom of the market downtrend, there were plenty of bad news, and people reacted by avoiding the market, treated like monster, instead of beginning to invest at low price.


System Archetype - Limit To Growth

Our life experience tells us that nothing grows forever, likewise nothing declines forever - sun rises, sun sets. It is the law of the nature.  

As a System Thinker, we expect a "Balancing loop" to interact with the above "Reinforcing" loop. As the name of the system archetype suggests - Limit to Growth, or Limit to Decline. We will now identify the dominant variable and construct the Balancing Structure. 

Theoretically there is a limiting factors in the economy. However most market players, being human, are more ruled by human desire and emotion, though some are conscious of the economy limits. When the price has been driven higher and higher, those who had bought earlier a low price, get excited and need gratification or take profit. They will initiate selling activities, which cause price to drop, though at first, price stabilizes and gradually drops. Over time, dropping price becomes more apparent, and the downstrend reinforcing loop takes over.

Likewise, the reverse is true, as price has been declining lower and lower, those who have cash in hand, get excited with the "dirt cheap price". They will initiate buying, which cause price to rise, though at first, price stabilizes and then gradually rises. Over time, rising price becomes more apparent, and the uptrend reinforcing loop takes over.


A Critical Factor - Delay

The most difficulty variable to comprehend and appreciate is the DELAY -  the consequences or unfolding patterns that takes TIME to form and for us to "SEE". By the time we really do see, it is "too late", the price is either too high to accumulate or buy or too low to sell or liquidate. 

Only minority will have cool heads to rationally think that price is high enough, take profit now. Hence with the rising price, driven by the reinforcing loop, "knowing or feeling that" price has risen too high, these minority starts selling, not noticeable to the general public.  Likewise, Only minority will have cool heads to rationally think that price is low enough, start buying or accumulating now. Hence with the falling price, driven by the reinforcing loop, "knowing or feeling that" price has fallen too low, these minority starts buying, not noticeable to the general public.


What Do the Structures Teach us?

From the above discussion, we can derive learning to be skillful investors as follow:

  1. It is the structures (reinforcing) that drive the prices higher and higher, or lower and lower. hence we need to pay attention to the Structure, NOT EVENTS, whatever may be the logic of the then current situation, news or rumor.
  2. Limit to Growth Structure teaches us to pay attention to the DELAY factor, watch up for the unfolding pattern to detect accumulation at the bottoming of the prices, or gradual selling at the topping of the prices. 

For the 1st learning, we need to develop discipline not to react at the Event level. 

For the 2nd learning, this QuaSyLaTic provides training service on QuaSyLaTic Investment System.



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