Unveiling the Driving Forces of the Market and fundemental trends (2023)

The financial markets are complex systems influenced by various factors that drive price movements and determine market behavior. The goal of a market is to facilitate trade through price discovery to properly assess the price of numerous assets. Understanding what moves markets helps traders and investors secure a profit.

In this article, I will explore four key drivers of what causes price moves in the financial market including

1. Monetary policy
2. Market sentiment
3. Supply and demand dynamics
4. Fundamental Factors

Let’s dive right in. 

Monetary Policy

The first and arguably most important piece of information for the markets is the monetary policy. Monetary policy includes mostly money supply and interest rates. When the government seeks to strengthen its currency (typically to reduce inflation) it will adopt rate hikes and quantitative tightening (a hawkish stance). When it seeks to improve economic growth and activity it will reduce interest rates or print money (this is a dovish stance). 

Changes in monetary policy can have a significant impact on the market, as they affect investor sentiment and risk appetite. This is the biggest driver as to whether the overall stock market is bullish (trending upwards) or bearish (trending down). Knowing monetary policy can help investors be more aggressive or less aggressive at certain times with their investing. If you prefer a much more simple approach to investing I would recommend this strategy. 

Market Sentiment

Market sentiment refers to how market participants feel and influence a specific asset price or sector in the financial market. Many types of sentiments exist [link] and are influenced by numerous factors. The biggest sentiments are risk on and risk off which determine if money is flowing into risk assets [link] or out of them. Economic indicators, geopolitical events, news releases, market expectations  and investor psychology are a few of the factors.

Conversely, negative sentiment, fueled by economic uncertainty or geopolitical tensions, can trigger selling pressure and downward price movements.

Understanding market sentiment is crucial for traders and investors as it helps anticipate shifts in market direction and identify potential trading opportunities.

Supply and Demand Dynamics

Supply and demand dynamics are fundamental drivers of market movements. Price discovery happens when the interaction between buyers and sellers determines the fair price of a market. Several types of market exist [link]. The biggest ones are balanced and trending markets. 

Balanced markets occur when the price of an asset is fairly priced and the market will stay within 2 prices. For more information on why this happens I would check out the article on supply and demand. An example is crude OIL in 2019 where it stayed rangebound between 51 and 66. 

In this situation, the sentiment of the market was neutral based on supply and demand of crude oil for the year. In this case, supply and demand affected the price of the market by not letting it outside of the established range. Knowing this market condition is key to understanding the driving force behind a market. 

In other instances the market will be trending. In a trending market, the price will move directionally from one point to another. In the case of the S&P 500 futures market (similar to S&P 500 index fund), it was a trending market in the year 2021. The market started low and went higher for the whole year indicating a trending market. 

When demand exceeds supply, prices tend to rise, reflecting a bullish market sentiment. Conversely, when supply surpasses demand, prices tend to decline, reflecting a bearish market sentiment. In balanced markets the price of the instrument will stay between 2 prices. Traders analyze supply and demand imbalances to identify potential price reversals or trends.

Fundamental Factors

Fundamental analysis focuses on evaluating expectations based on news events. Monetary policy is a fundamental factor that was discussed before. Others include Non farm payroll, GDP Growth, core inflation, Opec meetings, WASDE report. It’s important to note that these news events will only affect specific instruments. Opec (organization of petroleum exporting countries) meeting will mostly affect Crude oil futures whereas the WASDE report will affect mostly agricultural products. It is important to know what news events will affect which instrument especially if you are invested in it or trading it. 

By analyzing these factors, traders and investors can assess the underlying health and potential future performance of an asset. Fundamental analysis helps identify undervalued or overvalued assets, providing insights into long-term investment opportunities. It is particularly relevant for investors with a longer investment horizon and those seeking to build a diversified portfolio.

Conclusion

Understanding the driving forces of the market is essential for successful trading and investing. Monetary policy decisions by central banks, market sentiment, supply and demand dynamics, and fundamental factors all play significant roles in financial market price moves. 

The better understanding you have of why the markets move the better you can profit on these moves. 

Let me know what’s your favorite style of predicting market moves. And let me know if there is another topic you would like me to explore. Leave a comment and join our email list for more articles like this. 

And always limit your risk,

Andrew Akl

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