A bear squares off to a bull at Frankfurt stock exchange
This is not a post about basketball or American football. It is about the stock exchange. We frequently speak of Bull markets and Bear markets. Today is the anniversary of Black Tuesday in 1929 and one of the worst bear markets in history. Wednesday 30th October 1929 saw a bear market rally, which is also known as a suckers rally or a dead cat bounce.
So Bull markets are when things are on the up and up. Bull markets are positive, shares are gaining in value and traders are happy. All decisions seem to be good decisions. You buy a stock and the stock rises in value. You sell the stock and you bank the value.
A bear market is one that is heading down. If you buy a stock in a bear market you instantly see your value fall. That makes people sad and discourages trading.
In a bull market trading is brisk and fluid. In a bear market the trading stagnates. So why do we call them Bulls and Bears?
There are many guesses as to the origin of the terms and I don’t have any conclusive proof, but here is what I believe. Bull derives from the Latin “Bulla” which is the term for a lead seal. Most legal transactions were carried out in Latin until relatively recently and Latin terminology still suffuses legalese. If you agreed a contract for a trade it could be nicknamed a Bull. In the same way that a letter from the Pope is called a Papal Bull.
The first stock market trading in derivatives in the European markets was on Ships cargoes. Amsterdam and London were the early leaders in stocks, as the hubs of trading for the Dutch East India Company and the British East India Company respectively. As an example let’s look a the British Tea trade.
A ship owner sends a ship to China to pick up tea. That ship may be the first of the season to return, when the market is empty of fresh tea. If that is the case he can make huge profits on the tea. But if he arrives a month later, behind the majority of the fleet, he may find the market saturated with tea, and prices could be rock bottom.
To hedge against uncertainty the ship owner sells tea contracts. Each contract is sealed with a bulla, so they are nicknamed bulls. The contract for tea is at a fixed price. Let’s say it is for one crate of tea for the price of 1 pound sterling.
As the tea season approaches the mood of the market begins to shift and fluctuate. If last years tea has run out there is a lot of interest in the new stock. The contract at a fixed price may be a good bet. Traders will place bids to try to buy the contract for more than face value. So a Bull for 1 pound may rise in price to 1 pound and six pence. There is a market for contracts, or a “bull market”. Every time a contract trades the price rises. Ship owners may be encouraged to sell more of their pending stock as contracts in such a market.
On the other hand if there is a rumour of a tea glut in China then the traders may be happy to wait for the ships to arrive and for the tea auctions to establish the market price. There is no interest in buying the bulls. Any offer to purchase a contract is below the face value already paid. The owners of contracts are left to “bear” the price they have paid up front. They may have paid more than the tea is worth on the open market.
So a bull market is where trading is attractive and a bear market is stagnant or shrinking.
The bear market rally occurs when prices are falling. Everyone is feeling bearish and trading volumes fall. Prices stagnate. Some traders believe that the lower price now represents a new floor value and that the share price will rise again. They buy shares, raising the price a little on low traded volumes. Then the falling dynamic cuts in again, and the cagey traders release larger volumes of stock onto the partially stable market. The result is a headlong tumble, and those traders who bought at the new floor realise they have been suckered.
It was Munehisa Homma, the Japanese Rice Futures trader, who first understood that prices of derivatives have more to do with emotion of traders and the herd mentality than with the physical value of the commodity. Time and again we have seen boom and bust cycles driven by psychology rather than economics, Mississippi Property, Dutch Tulip Bulbs, South Sea Company, 1920’s Florida property, the British Railway bubble, the .Com bubble, Enron and all the way up to the Irish Property bubble of 2007. All driven by buyer psychology.
Homma was nicknamed the God of the Market because everything he touched seemed to turn to gold. Sort of an 18th Century Japanese version of Warren Buffet. He is also known as the father of the candlestick chart, an elegant method of capturing activity in a market. The “Candle” is a rectangle which describes the opening and closing positions in the market while the “Wick” indicates the highest and lowest traded prices in the session. By charting market movements Homma could see what psychology was doing, and could make market predictions that gave him an edge over traders who were reacting to circumstance.
Now there is an entire science founded on the candlestick chart. It comes with enigmatic Japanese terminology to describe patterns, the hanging man, the inverted hammer, three black crows or three white soldiers. For each pattern there is a predicted response. But now that the responses have been programmed into computers there is almost an inevitability to certain market movements.
Of course, if you know what the computer programmes will do, a savvy trader can still find an edge…..or can they?