We've all had bad experiences on the stock market, haven't we?
Do you remember the time you found a great stock with good news coming up and that was going up strong? But just a few days after you buy stock in that company, it goes down and you lose money? Even worse, what if you had bought that stock with futures instead?
Didn't you wonder why such strong stocks would drop so much? In fact, why do stock markets as a whole even pull back?
There is a reason for this, and it is called the "Law of Diminishing Marginal Utility" in economics. The Law of Diminishing Marginal Utility says that as a person uses more of something, the satisfaction (marginal utility) of having that thing decreases with each additional unit of that thing.
Too general? Well, in everyday language, it means that the more of something someone has, the less satisfaction they get from it. Do you know what a buffet is? Can you remember how good it felt to eat for the first time after going without food for a whole day? But can you remember how each new plate of food makes you feel less satisfied, until you can't get any pleasure from eating at all?
The stock market is going through the exact same thing.
As more and more money is made, it's less satisfying to make a profit and more scary to lose the money you've already made. There will come a time when the pleasure of making more money will be replaced by the fear of losing the money that has already been made. From that point on, investors start selling to make money, which causes the price to go down. People seem to have a strangely strong connection at that point, and once the first person takes a profit, the rest give in to their fears and sell off as well.
When was the first time you made money on the stock market? Do you remember how it felt the first time the numbers in your trading account turned green? You were very happy, right? You wanted to make more money, right? But do you remember how uncertain you got as the profits went up and up? Did you wonder if you should keep going and try to make more money or just quit while the going is good? Did you reach a point where the fear of losing that profit took away all the pleasure you could get from making more money? So, what did you do?
Now, though, we all know that, don't we?
So, the Law Of Diminishing Marginal Utility made sure that neither stocks nor markets went up all the time, so that only the most disciplined and patient investors could consistently make money. Are you that type of patient and disciplined investor?
