What Really Moves the Market?

Why Traders Chase Supply & Demand, While Investors Trust Valuation.

In my letter on 19th September (read here), I discussed how the U.S. Fed’s rate cut of 50 basis points could impact the Indian market.

As predicted, the added liquidity has flowed into the market.

In the short term, this has pushed the Indian market higher, and it continues to reach new peaks every day.

One of my learners called me after reading my previous letter. He sounded concerned and asked, "Kundan sir, the market is already at a high valuation. Do you really think it can keep going up after this?"

I agreed that the market was trading at a high P/E. But I explained that, in the short term, the market often reacts to supply and demand factors. However, in the long run, it seeks its true valuation. So, as an investor, he shouldn't be swayed by this news. But as a trader, he should consider such events and position himself wisely, especially for risk management.

This brings us to an important distinction that every market participant must understand: the difference between short-term movements driven by supply and demand, and long-term trends shaped by valuation.

Recognizing this is crucial, whether you're an investor focusing on long-term value or a trader reacting to short-term events.

To make informed decisions, it's essential to identify your approach—are you an investor or a trader?

Both supply and demand, as well as valuation, play crucial roles in driving the market, but they do so in different ways and over different timeframes.

1. Supply and Demand:

• Short-term Movement: The market's short-term price movements are primarily driven by the forces of supply and demand. When more investors want to buy a stock (demand) than sell (supply), prices go up, and vice versa. News, market sentiment, geopolitical events, earnings reports, and economic data can all affect investor behavior, causing shifts in supply and demand.

• Market Speculation: Traders often react to short-term events, causing fluctuations in price that might not align with the underlying value of a stock. This phenomenon explains why markets can be highly volatile in the short term.

2. Valuation:

• Long-term Movement: In the long run, the market tends to align with the true intrinsic value of assets. Valuation metrics like price-to-earnings (P/E) ratios, discounted cash flow (DCF) models, and other fundamental analysis tools help investors determine whether a stock is overvalued or undervalued.

• Corrective Mechanism: If a stock is overvalued (price is higher than its intrinsic value), eventually the market will correct itself, often driven by financial performance or changes in fundamentals. Similarly, undervalued stocks may attract more buyers over time, pushing prices up to reflect their true worth.

In summary, supply and demand often dominate market movements in the short term due to investor sentiment and speculative trading. However, valuation is the key driver of market trends in the long term as markets eventually gravitate toward the true value of assets. Understanding both aspects is crucial for effective trading and investing.

The market will move as it does, but your decisions should come from knowing who you are—a trader or an investor. Self-awareness is the key to navigating the market’s highs and lows.