Physics of the markets. A thread.

Markets follow certain laws again and again, just like physics. They are at the core of most strategies and
set-ups that various practitioners use. If you understand these basics you can make much better sense
of the markets.

Here’s a rundown. 🏃‍♂️

1. Momentum - The lesser I say the better given how much this concept has been used off-late. But
momentum remains a tendency that works more often than not. It could be driven by price or earnings.
Once a new momentum starts it opens up an opportunity to make money.

Now you could do abs or relative momentum. You could rebalance frequently or not. You could run it on
small caps or large caps. It works. Of course it has its nuances which is related to another law. Just look
at the last three months return of nifty alpha50 and you would know.

Which is, beware of stale momentum. If you get into a stale momentum situation you get to face the
wrath of the next law of markets.

2. Mean reversion: Markets have an uncanny need to mean revert. They typically mean revert either
over short term or the long term. Short term mean reversion is the playfield of intraday traders and
straddle sellers. Long term mean reversion is where the value investors reside.

You will see mean reversion playout time and again in the markets. Whenever you see more than 90%
of the stocks in the negative over any time frame you can expect a quick bounce back. This happened
last week and we will likely see the mean reversion play out over next few days.

3. Demand-Supply Dynamics: if a stock or sector is over-owned it will tend to under-perform and if it’s
under owned it will be primed to outperform. The FAANGs are massively over owned after a ten year
bull run and are more likely to underperform. Similarly cap goods in India is

under owned and is likely to outperform over next few years. A quick check of past few years of return
and the news will tell you what’s over owned. Crypto is possibly over owned. Everyone who had to buy
has bought. It’s likely to underperform for a few years by that metric.

Another aspect of demand supply is float. Low float leads to large moves and high float or frequent
equity dilutions etc will lead to more subdued performance. This works only over short and medium
term.

4. Growth: Markets love growth. It’s not a law but is almost one. If you can demonstrate growth in
revenue to markets it will bend over backwards to give you money. That’s why new categories are the
biggest winners in any market. The base is small and they give you 100% growth,

and the market re-rates them to the moon.

5. Environment - This is probably the most important law. Just like in physics the frame of reference is
key. You have to be able to figure out what type of a market environment are we in? Is it bullish,
bearish, choppy or volatile or any other adjective you can think of.

The environment will decide 80% of whether you will make money or not. Every strategy has a
conducive environment. Momentum works only in bull markets. Value (Mean reversion) works in
extremely bullish phases or generally bearish phases.

Similarly there is a time to be aggressive and a time to be defensive. Every major decision depends on
the environment and your understanding of your strategy vis-a-vis the current environment. Stopping a
SIP in a bear market is probably the worst thing you can do as SIP

Works it’s magic in bear markets. No point doing sip in a bull market. Know the market environment and
make decisions accordingly. Newton’s laws don’t work in sub-atomic particles. Why? Different
environment.

That’s all. If you run any strategy that doesn’t belong to one of the above core laws of the market, let me
know