What are {term}? Market Dynamics

Market dynamics are pricing signals that are created as a result of changing supply and demand levels of products and services in a given market. It 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 are known as 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. However, not all variables are easily quantifiable. Models of markets for physical goods or services with relatively straightforward dynamics are, for the most part, efficient, and participants in these markets are assumed to make rational decisions. In financial markets, the human element of emotion creates a chaotic and difficult-to-quantify effect that always results in increased volatility.

On the one hand, in financial markets, there are 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 possess limited knowledge about markets. This includes small-to-intermediate traders who seek to “get rich quick,” 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 sometimes dishonest. For savvy professionals, all decisions are based on comprehensive analysis, extensive experience, and proven techniques.

The Dynamics of Greed and Fear

Competent professionals determine entry and exit points of an investment/trade using 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 investor or trader, once the trade is executed, if the trade becomes profitable, greed will prompt traders to not take profits eventually resulting in a winning trade becoming a losing trade. For losing trades, 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 models.