Understanding the market during a crisis
People have two different patterns of behavior. The initial pattern is the normal set of rules for everyday life. Then, the second one is the crisis mode - when normal rules entirely break down and begin to think differently if they wish to survive.
Crises are rare. Thus, people always forget about them and think they are rarer than how they should be.
It is quite challenging for most people to make the mental change between normal and crisis - not until they see the danger coming straight at them. For our ancestors, this was enough because they get worried by an attacking wild animal while hunting or by people from a rival tribe.
But for modern humans, it won't be enough. They face dangers that would only be seen up close until it's too late, despite having intellectual tools to comprehend them and the technology to beat them.
The perfect example of this is the coronavirus pandemic of 2020. The pandemic might have stopped in China, but people and governments moved too little too late, even if they knew what was going to happen if they didn't act up.
Now, this might be because a pandemic had not been seen within living memory in the western world. With that, people can't believe that it could actually happen. Even though institutes and scientists are working day by day to warn people that it was only a matter of time before it occurred.
Financial Markets
Human buyers and sellers drive financial markets. Also, it runs in two modes: the normal markets and crisis markets. To become successful here, a trader must identify when a crisis drives the markets and whether there's a reason to panic or not. After that, the trader must apply different trading rules in each type of market.
Aside from that, it is essential to differentiate between a relatively small crisis and a real panic, which we call a 'world crisis.' Great examples of real-world crises during the past century are the Second World War from 1939 to 1945, the Cuban Missile Crisis of 1962, the Financial Crisis of 2007-2008, and the Coronavirus Pandemic of 2020.
Determining a World Crisis
There are two manageable rules to use to tell whether it is a world crisis or a normal smaller crisis. The first one is if the markets move consistently with abnormally high volatility.
People can measure this by applying the average true range indicator over the long term and compare it to the recent daily ranges of forex, stock, and commodity markets. When current ranges persist for some days at levels far over their long-term averages, and stock markets are generally declining, then it is clear that a major crisis is going on.
Then, the next rule is not mathematical; it is more emotional. If there is someone following the news saying in fear, "I can't believe this is happening, it can't be real," and crashing stock markets are on very high volatility, then that is a real-world crisis.
This article was submitted by Finmarket.
