Following on from our previous article “Why Markets Sell-off”, we now look at the dynamics of the sell-off once the peak has passed and why markets stop selling off. The selling action can be categorised into three stages.
1. Profit taking, risk aversion
2. Herd behaviour, stops, speculators (Froth)
3. Value hunters, risk seeking, re-entry
As we move from Stage 1 to 3, it is the shift in balance between buyers and sellers that determines the velocity and duration of the sell-off. But what drives these interactions can be explained by behavioural finance, and in particular prospect theory.