Wall Street Cheat Sheet

Last Updated on May 18, 2023

Wall Street Cheat Sheet

The only difference between a profitable trader and a non-profitable trader is how they control their emotions. While the latter always shows the right emotions at the wrong time (often leading to wrong calls in the market), the former understand their emotions and use them at the right time. To succeed in the market, you need to understand the psychology of the market, which is why we bring you this Wall Street cheat sheet.

This Wall Street cheat sheet breaks down the psychology of market cycles and shows the different emotions that play out. As you know, the market moves in cycles, and these cycles repeat themselves over and over again. The cheat sheet shows what goes through the minds of market participants during the different stages of the market cycle.

In the chart above, you can see the different emotions that play out in the market. Let’s explore them one after the other.

Disbelief

This is the usual emotion when a new trend is emerging in the market after a bear market. It probably starts with short-sellers covering their short positions. Some experienced investors might come in at that early stages, but amateurs would remain on the sidelines since they doubt whether the rally will continue (maybe based on some past experience or lack of knowledge thereof). If the rally grows into a full-blown uptrend, those doubters would either start regretting or hop on to the trend at the later stages out of fear of missing out (FOMO).

Hope

Following the initial rally, the price reaches a moment of temporary consolidation and retracement but traders and investors believe the security has a lot of potentials. Here, we will see people who missed the first rally coming in bit by bit. This phase as seen on the chart is a period of accumulation for what’s to happen next.

Optimism

As the market momentum picks up, more and more investors rush into the market to get a piece; they are full of optimism at this point. This stage sets the pace for the boom stage as it gets media coverage.

Belief and thrill

At this stage, the market is getting a lot of media coverage, and everyone is talking about it. This is where most people get into the market as a result of FOMO (Fear of Missing Out). This phase usually comes with a continuous rally as more and more buyers come into the market. Here investors will start recommending the asset to relatives and friends as Fear-of-Missing-Out and what seems to be a lifetime opportunity gives birth to speculations and widespread optimism. An example of this is the Gamestop frenzy and the DogeCoin (cryptocurrency) rally earlier this year (2021).

Euphoria

This phase comes with extreme price levels, oscillator reading reaches extremes, but caution is thrown to the wind. Investors and the public will use metrics and new valuation measures to justify the continuous rally. Here the “greater fool” theory comes into play — that no matter how prices go, there will always be buyers that are willing to buy at any price.

At the height of the internet bubble of 2000, the value of all technology stocks on the Nasdaq exchange was higher than the GDP of most countries.

Complacency

In this phase, market momentum comes to a halt, and then comes a retracement. However, this retracement is soon followed by a slight rally giving the impression of a trend continuation.

Traders still hold on to their positions while waiting for the trend to continue, thinking that it’s just a temporary retracement. What they fail to understand here is that the market has exhausted its move and is ready for a trend reversal.

Anxiety and Denial

In this stage, smart money starts taking profits and selling positions as they heed the warning sign that the market bubble is about to burst. But retail investors would think that the market will bounce back.

Panic, Capitulation, Anger, and Depression

The last stages of the market cycle come with a lot of market decline. In this phase, the bubble is burst. Prices of securities decline faster than they had rallied. Traders and investors are faced with margin calls and a reduction in the value of their positions. Many will capitulate and liquidate their positions. What follows is anger and depression.

Final words

The market is made up of people and their emotions. It’s important to know the emotions driving the various stages of the market cycle so you can plan what to do ahead of time. Don’t get cut up in the game.