Andrew Wong 11rd
Stock Market &
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 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
|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
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
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
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.
Factor - Delay
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
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:
- 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.
- 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
For the 1st learning, we need
to develop discipline not to react at the Event level.
For the 2nd learning, this
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