Market Drawdowns Are Just Overreactions

Every so often, we, the people of the financial markets, are presented with an opportunity. An opportunity to buy the things we want at a discount. A heavy discount.

And guess what…it always comes back up when we want to sell!

Market drawdowns are a fantastic lesson in the psychology of people, rather than a study in macroeconomic trends or financial consequences of businesses during earnings.

People are people, and people run markets.

Let’s imagine that there’s a terrible earnings season across the board for tech. QQQ, and ETF that tracks the Nasdaq decides that it doesn’t like being worth $600 anymore, and casually nose dives down to $560 over the course of the following two days.

Did QQQ really decide that? No, of course not. Investors saw what was happening and decided to sell their shares before others notice the earnings are bad in the tech world, which would rinse the value of their shares.

Problem? Everyone noticed at the same time.

So ensues yet another massive downward movement in QQQ, causing more and more people to sell “before it’s too late”.

2, 3, 4 days later, someone enters the market. Who could it be?

It’s the arbitrageurs, the people who don’t think one bad earnings call across an industry is enough to tank one of the most successful ETFs of all time by 7%. So they buy. And buy. And buy.

QQQ gets more positive buy volume, and the price begins to rise.

Now, it’s important to note that it will likely NOT go back to $600. It might stay lower. But the initial sell off was absolutely an overreaction. Because, as we know, humans are emotional and therefore make irrational decisions to protect their pride…and cash.