John Maynard Keynes famously said that “markets can remain irrational longer than you can remain solvent”. Let’s explore why the market tends to be irrational, as Keynes suggests.
One thing is certain: markets are not linear. They don’t rise in a straight line, nor do they fall in a single move. It is much more complex than that, and this complexity makes analyzing and predicting market movements one of the most challenging activities in the world.
This complexity arises because the market is composed of billions of decisions that together form the prices we see on screen and the patterns in each chart. Therefore, we are not just analyzing a number but the millions of decisions behind that number. Overwhelming, right?
Often, we read analysts or traders complaining about the market’s irrationality, about movements that are not consistent with reality and that cause them to lose money.
Keynes’ phrase is a great truth and is often repeated throughout history, from senseless downturns to FOMO rises that seem to have no ceiling, where in both cases the rational trader is left out or loses money.
But the reality is that while the market does exhibit irrational behaviors, these tend to occur in very short periods of time, meaning they are confined to the short term.
In the long term, all markets are rational. By rational, I mean they adjust to the reality of the asset in question and its supply/demand. Here, the saying that in the long term, the chances of success increase holds true.
But this is partially true because if we choose the wrong asset, the passage of time alone will not give us returns. And citing Keynes again, “in the long term, we are all dead” lol.
Therefore, the important thing when analyzing a market is to know that it often behaves irrationally, although in the long run, this irrationality tends to rationalize, and this is where the fundamentals of the asset in question come into play.
The key is not to seek rationality when what we see is irrational, but rather to adapt to this irrationality to know how to coexist with it, operate it, and reap the most benefit from it.