Are the markets more Math or Emotion?

The stock market is a method of investing in individual companies. The market determines the current value of each of the companies traded on the exchange. Since the market deals in dollars and cents, it stands to reason that the market is more based on logic, research and process (Math) than how market participants feel on any particular day (Emotion). However, depending on the day, the opposite may be true.

Each business day, shares of stock trade on the New York Stock Exchange. Each share of stock represents an ownership percentage of a specific company. If you know how many shares of stock a company has outstanding (in circulation) and you know the current market price of a share of stock, you can quickly determine the market value of that company. Depending on a company’s prospects, growth rate, dividend policy, etc, market participants will either bid up or down the price of specific company shares based on the data (or Math).

But at the same time, other shareholders are exuberant that the price of their stock continues to go up. Other shareholders are depressed that the price of their stock continues to fall. Humans are not robots. We feel emotions. These emotions affect our decision making process. As I’ve mentioned before, losses affect us twice as strongly as gains. The fear of losing money drives market panics. Similar to a bank run, once people start to get out, more and more people run for the exits. On the opposite side, if you have money to invest and the market continues to march higher, there is a fear of missing out. You have to get in, even though you know that you should “Buy Low”.

A lot of the determination of whether the market is more math or emotion is dependent on your time frame. In the short term, it seems that emotion drives the market. Market participants feel exuberant and the market shoots higher. People get scared and the market drops like a rock. But over the longer term, the market moves above and below a market average that is determined by the math. That math takes into account the health of the economy, profit projections, etc. And while the math can make the market rise and fall, in the end, it is the math that matters most…in my opinion.

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