How Financial Markets Really Work
Markets are not rational price-discovery machines. Understanding what they actually are changes how you relate to them.
12 min readThe Efficient Market Myth
The efficient market hypothesis — the idea that market prices reflect all available information at all times, making it impossible to consistently outperform — is a useful academic construct that describes market behaviour poorly in practice. Markets are not perfectly efficient. They are populated by human beings with emotions, biases, time horizons, and incentive structures that produce predictable irrationalities. Prices overshoot and undershoot. Bubbles form and burst. Narrative drives prices as much as fundamentals. Understanding that markets are imperfectly efficient does not mean you can easily beat them — but it does mean you can avoid some of the worst mistakes that efficient market thinking encourages.
Markets are not rational. They are human. That has predictable implications for how they behave.
How Narrative Drives Prices
Asset prices move as much in response to stories as to fundamentals. The story that surrounds an asset — its future potential, its role in a trend, its symbolic value — shapes how investors feel about holding it, and how much they are willing to pay. This is why valuations can reach levels that are difficult to justify on any fundamental basis during bull markets, and why assets can trade below obvious fair value during panics. Identifying when narrative has diverged significantly from fundamentals — in either direction — is one of the most useful skills in understanding markets. It does not require being an analyst. It requires being a critical reader of the stories being told.
When a market story is everywhere, ask: what would have to be true for this to be right? Then ask whether it is true.
Market Cycles: Sentiment and Structure
Markets cycle through recognisable emotional phases: disbelief (early recovery, dismissed by most), hope (trend established, early adopters positioned), optimism (mainstream awareness), euphoria (everyone is in, prices seem to only go up), complacency (first signs of trouble dismissed), anxiety (trend reversing, denial), panic (selling accelerates), depression (sellers exhausted), disbelief again. This pattern repeats across markets and asset classes over different timeframes. You will not time it precisely. But knowing where in this cycle a particular market appears to be — based on sentiment, valuations, and media coverage — is genuinely useful context.
When markets are on the front page of mainstream news, they are usually late in a cycle. When they are ignored, they are usually early.