Market Dynamics

What are 'Market Dynamics'

Market dynamics are pricing signals that are created as a result of changing supply and demand levels in a given market. Market dynamics describes the dynamic, or changing, price signals that result from the continual changes in both supply and demand of any particular product or group of products. Market dynamics is a fundamental concept in supply, demand and pricing economic models.

BREAKING DOWN 'Market Dynamics'

Any change in either the supply or demand for a specific product or group of products forces a corresponding change in the other, and these variances cause pricing signals. In a free or open market in which no entity has the ability to influence or set prices, the price of a good is determined by the market, which consists of the buyers and sellers, collectively. A single entity or group, therefore, is unable to have a significant effect on market dynamics.

Market Dynamics of Securities Markets

Economic models attempt to account for market dynamics in a way that captures as many relevant variables as possible. Yet, not all variables are easily quantifiable. Models of markets for physical goods or services with relatively straightforward market dynamics usually indicate that these types of markets are for the most part efficient, and that participants in these markets typically make rational decisions. For financial markets, there is one ever-present element that creates a very chaotic and difficult-to-quantify variable that always results in increased volatility.

In financial markets, the presence of human emotion presents a different market dynamic. On the one hand, there are the financial professionals who are knowledgeable about how markets work, and therefore make rational decisions that are in the best interests of their clients, based on all available information. On the other hand, there’s a sizable number of market participants who are not professionals, and have limited knowledge about markets. This includes small-to-intermediate traders who seek to “get rich quick” by trading markets, or investors who attempt to manage their own investments rather than seek professional advice.

Also included in this group are self-proclaimed professionals who are not very knowledgeable, or are incompetent or sometimes dishonest. For the savvy professionals, all decisions are based on comprehensive analysis, extensive experience, and proven techniques.

The Dynamics of Greed and Fear

For the competent professionals, entry and exit points of an investment/trade are determined by proven quantitative models or techniques. Strict money management is practiced, and trades are executed without deviating from a predetermined plan. Emotion never influences the decision making process. For the novice investors/traders, once the trade is executed, if the trade becomes profitable, greed will prompt traders to not take profits in lieu of wanting more, eventually resulting in a winning trade becoming a loser. For trades that are losing, novice traders are overcome by fear and are inhibited from exiting at the stop loss. These are examples of emotional irrational behavior and are very difficult to capture in economic model.