Emotional-driven risk preferences can significantly impact stock prices

At times, we often witness stocks soaring without any particularly good news, or plummeting without apparent negative news. This phenomenon is unrelated to fundamentals but is driven by emotional-based buying or selling, resulting in shifts in supply and demand dynamics.

When a new emotional spark ignited by "fundamentals" is validated by price increases and amplified by media hype, it can lead to a frenzy among market participants. Fear of missing out drives investors to buy in, pushing prices higher without any fundamental changes.

Such intense bullish sentiment often dissipates under two circumstances:

1. Expectations materialize into reality, prompting profit-taking. As prices decline, those who bought high start selling, triggering further selling, leading to a market collapse until the next wave of expectations arises.
2. Clear bearish risks trigger market flight to safety.

These bearish risks include systemic risks like wars and interest rate hikes, as well as sudden news affecting related industries, such as peer company earnings reports or profit declines. Uncertainties about the future, regardless of their actual impact, greatly reduce people's risk appetite. Reduced risk appetite prompts some risk-averse individuals to sell risky assets, causing the stock market to decline.

So, how can one identify the signs of a downturn before it happens?

1. Observe signs of reduced market risk appetite: interest rate hikes, bank failures, geopolitical conflicts, natural disasters. Typically, when such news emerges, stock prices don't plummet immediately but enter a period of subdued trading. It's only when the risks intensify slightly further that sudden steep declines occur.
2. Exit before facts materialize. This is especially crucial when the positive facts aren't ongoing but are one-time events, such as Bitcoin halving.

Of course, these observations are more relevant for short- to medium-term trends, measured in weeks or months, rather than long-term trends measured in quarters or years. In the long term, fundamental analysis remains paramount.