Why Do Markets Trend? 3 Words: Simple Human Behavior

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Markets move in trends. We can observe trends in any financial market, at any time. The price of the metals you buy move in trends and as you well know, industrial metals have been in a downtrend since the spring of 2011.

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So why does the price of your metal trend? Is it that the stars align and that produces a trend in a commodities market?

Copper trends (2000-2014)

Copper trends (2000-2014). Source: MetalMiner.

Heck, no! Traders are the ones making prices move and behavioral finance can help explain why trends are formed. We’ll mention three human behaviors to explain it.

Herd is the Word

When prices have already moved up or down for a while, many traders will just jump on the bandwagon. This effect can feed upon itself, making the trend last longer. This herd behavior happens for two reasons. The first is the social pressure of conformity, following the group is the ideal way to become a member. The second reason is herd mentality: the common thought that it’s not likely that a large group can be wrong. An investor might follow the group in an irrational way, believing they know something he or she doesn’t.

Confirmation Bias

We as humans tend to filter and pay more attention to information that supports our opinions, while we ignore the information that doesn’t. Just look at the success of Fox News and MSNBC for confirmation of this.

Investors do the same thing. If prices have been moving up and they are bullish, they will tend to look for information that confirms what they already believe rather than seeking out information that contradicts it. This can lead traders to move capital into metals that have already moved up in price while withdrawing money when the metal price has already declined, causing trends to continue.

Anchoring

When your metal price has been moving up for a long time (long-term uptrend) and suddenly it falls in a short time period (short-term downtrend), many investors will see this as an opportunity to buy the metal, anchoring on a recent “high” that the metal achieved and believing that the price drop provides an opportunity to buy the metal at a discount.

The same happens in downtrends, when investors see opportunities to sell/short the metal when prices bounce back up. This provides support in uptrends and resistance in downtrends, further propelling these trends.

What This Means For Metal Buyers

Traders are what move metal prices and they, as humans, behave in irrational ways. This irrational behavior makes prices move in trends. Industrial buyers want to be on the side of the trend, hedging in uptrends while buying as needed in downtrends.

 

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