Basics - My Understanding of the Investment Cycle

Now, I am pretty sure that you've been taught the food chain in your elementary education many many light years ago. For those of you have a bad memory like myself, allow me to remind you. The food chain, graphically, look something like this: at the lowest level are the plankton. The plankton is consumed by krill. Krill in turn is consumed by small fish which are themselves food to larger fishes. The larger fishes are then consumed by large animals of prey such as eagles in the air and sharks in the sea.

When I reflect upon the market's activity over the past 2 weeks, I can't help but notice parallels between the stock market and the ecosystem.

To me, the stock market is really a jungle. There's the predator, and there's the prey. The predator is the fund manager. The funds with their technical know-how and billions in cash, really have weight to throw around. The funds have two poweful weapons in their arsenal:

1. Loads of money - they can really make a splash in the market and force prices to change via maniplation of supply and demand.
2. Psychology of the prey - they can devour the small potatoes of the market through playing on their fear and greed.

The central dogma of the stock market is something you've heard before - buy low and sell high. The predator pursues this as well. They sell to the general population when prices are high. The prey, excited by the hype in the market, buys massively overpriced stocks - dangerous! Then the market fails to fly any higher because everyone who wants in on stocks has already exhausted their funds to purchase stocks. With no more buyers, the high priced stocks will begin to drop. Once the market has peaked, the fund managers will sell short their stocks, hoping to make a killing as the market drops like a rock. The funds then sit and wait, almost like patient poachers. As the market continues its freefall, the public will naturally want out. "Oh boy, my life savings are evaporating faster than water droplets in a sizzling wok!" Out of fear, the small fish now sells his/her stocks at a fraction of the price they bought, finally deciding to cut loses. At the end of all this, the moment the predator has been waiting for all along, the market is completely oversold. Funds stealthly move into the market and buy up the heavily discounted stocks. Soon, on the spur of "good news" and a series of upgrades (never underestimate the power of the Wall Street Promoting machine) the market will look better than ever. At this point, the general public (aka the prey) will begin to purchase stocks. The good news coupled with the increased buying will force stock prices to new highs. Powered by greed, the investor will now plunge his/her savings into the market if not take out sizeable loans from the banks to purchase stock. Once again, this vicious (not so vicious for the predator) begins. The funds trade out of stocks and the small investor buys them at a markup. And eventually, as true as Newtonian physics, what goes up must come down. This is the so called business cycle or market cycle.