Over the years, I’ve had the privilege of travelling and speaking to different groups of people. These include students, working adults, finance professionals, seasoned entrepreneurs and retirees.
Each time we discuss the financial markets, I hear the same old grouses:
“It’s too difficult!”
“I don’t get the charts!”
“I don’t understand the numbers & the trends!”
“What on earth are the economists and analysts saying?”
The list goes on.
For some reason or another, getting a grip on the financial markets is like finding a needle in a haystack. Recently, billionaire Ray Dalio, the founder of Bridgewater Associates – the largest hedge fund in the world, wrote this on his LinkedIn:
“Since economies are the aggregates of the markets that make them up, to understand how economies work one has to understand how markets work.”
As a big fan of Ray Dalio and his work, I couldn’t agree more. We have to understand how markets work – once and for all.
Let’s dive into this article where I bare all on the secret to decoding the global financial markets.
Let’s look at 3 main components of the financial markets:
- Stocks
- Bonds
- Currencies
1. Stocks
Here’s a simple definition of stocks. Stocks are simply shares or ownership in a company. They are traded on the local stock exchanges in each country. Collectively, they are called the stock markets. You may have even heard this from a friend: “I own stock of company xxx” or “I have equity in company xxx.” All these refer to your friend’s ownership of that particular company. Stocks are normally called risk assets.
2. Bonds
Bonds are simply loans which governments or companies issue to attract capital from investors. These bonds are then paid back with interest (called coupons) after a certain amount of time. Bonds are normally called safe haven assets because they are deemed safer than stocks.
3. Currencies
The currency markets or the foreign exchange market, is considered the largest financial market in the world. According to a study by the Bank for International Settlements (www.bios.org), the foreign exchange market trades an astounding USD5.1 trillion in a single day.
Now that we have a working definition of stocks, bonds and currencies which generally make up the bulk of the financial markets, let’s go deeper.
Here’s the key secret to decode the financial markets – they are governed by emotions. Specifically, you have “fear and panic” on one end and “hope and greed” on the other end.
When the dominant emotion is fear & panic, money moves out of risk assets like stocks and into safe haven assets like bonds. This causes stocks to fall and bonds to rise.
When the dominant emotion is hope & greed, money moves into risk assets like stocks and out of safe haven assets like bonds. This causes stocks to rise and bonds to fall.
What about currencies?
Generally, currencies are also split into risk assets and safe haven assets:
Risk Assets – AUD, NZD and CAD.
Safe Haven Assets – USD and JPY.
When the dominant emotion is fear & panic, money moves out of risk currencies like AUD, NZD and CAD and into safe haven currencies like USD and JPY. This causes AUD, NZD and CAD to fall while USD and JPY will rise.
When the dominant emotion is hope & greed, money moves into risk currencies like AUD, NZD and CAD and out of safe haven currencies like USD and JPY. This causes AUD, NZD and CAD to rise while USD and JPY will fall.
Get this concept today – markets are dominated by emotions and move into either risk assets or safe haven assets all the time.
To your success,
Mario
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