The continuous market cycles that occur produce different psychological effects on those that participate.  For example, at the peak of the investment cycle traders and investors feel sanguine about the returns they've realized up to that point in the market cycle. This is usually followed by a sense of dread when they see those returns begin to gradually dwindle and eventually turn into losses.

Unfortunately, most traders and investors experience these fear and greed cycles time and again.  This is due to the simple fact that most traders and investors don't have a plan to properly manage risk and reward. Furthermore, they don't possess a clear understanding of probabilities as it relates to making trading decisions.  These deficits subject traders to making decisions based on their emotions of fear and greed.  In order to mitigate these emotions, traders need to have a strategy that can help them buy low and sell high. Easier said than done, as you might imagine. But without a strategy, trading and investing can be extremely challenging

In order to deal with some of these challenges, a trader/investor must understand the various stages of the collective psychology of traders and investors. These market cycles can occur over many years, but smaller episodes happen almost daily.

Psychology and Market Cycles

The emotion that accompanies the first phase of the market cycle is optimism. This happens when the market has been in a sustained uptrend for many months, perhaps years.  In this environment, the prospects for earnings and for the economy look rosy.   Traders are feeling comfortable buying, as they perceive little risk in putting money into the stock market.  As the market continues higher, optimism turns into excitement as the early buyers are starting to garner hefty profits and every pullback is seen as another buying opportunity.  This perception is there because buyers are being rewarded for purchasing every retracement.