The Psychology of Buying and Selling

March 27, 2024

The market goes up and the market goes down. Within a matter of months, what was a ten course degustation can quickly become turnip stew.  The fascinating thing is markets are all to do with psychology. The value of any item is a human construct. Money itself is a human construct. As we have seen with some new items of ‘value’ (looking at you NFTs), what humans can construct can be destructed just as quickly.  

To create a market, someone has to want to sell something and another person has to want to buy it and when those two get together on a single number, voila – it's market time. But we only need to look no further than paint on canvas to see the extremes of this principle. A painting by one artist can command millions whilst an exact copy of the same image costs the same as a night out at the pub. How does that work?  Let’s jump feet first into some of the madness that is markets in the context of agricultural commodities.    

Bids. First up is that a bid price is not the market price. Why? Because there may not be any sellers at that price. Let’s say that a grain buyer is short working capital and can’t buy any more grain until the next sale transaction comes through, so they drop their price $20pt as they know no one will take them up on it. Doom and gloom descends over the market as it's dropped $20pt. Except that is not true if no one sells at that price. The marketer could have dropped their price $50pt or $100pt – it makes no difference to the value of the grain, just to liquidity of the market at that point in time. The converse happens when there is nothing left to sell. Price for Faba Bean can rise 50% but it's meaningless if there is no Faba Bean left to be sold. So, unless there are buyers and sellers at the same price, a bid price is not the market price. Logically, the same goes for offer price.

FOMO. The reason a single original artwork is worth so much is scarcity. If 1,000 people want 1 item, the price will rise. If 100,000 people want it, then it will go higher still. The same goes for agricultural commodities for buyers and bid prices for sellers. If a meat processor has certain capacity to fill and they see the market supply dropping, then do they rush in and buy up limited stock or cut a shift to reduce the capacity? The fear of missing out (FOMO) drives prices. Similarly, a seller may see a bid price and think that it could be better but what if it falls further? Better take it whilst it's there. Again, fear drives market behaviour.

Anchors. There is nothing like someone’s memory to influence market behaviour. What price is written into farm budget forecasts? Typically, something very close to the price at the time of writing the budget. This is despite data indicating it will almost always be materially different (up or down) at the time of harvest. It’s not easy to anticipate the future but it is very easy to look at current pricing. Or maybe the five year average is used - slightly more sophisticated but still historical with no window into the future. Related to this is the one-way ratchet anchor, favoured by perennial optimists. This is where the market price is anticipated to be the highest it has been over the last season. If canola sold for $1,000pt in June, then that’s what the value it is regardless if the market is $650pt right now. This is also known as Recency Bias.

Sunk costs. Similar to anchoring is that once costs have been incurred, then that acts as a floor to price. Let’s say fertiliser prices are higher than normal so, theoretically, the return on crop value should be higher than normal. But to the goat herder in Oman looking to buy feed barley, there is zero linkage. To them, cost of production is irrelevant. Knowledge of costs is useful for informing future management decisions, but not marketing current production when costs have already been incurred.  

Herds. The herd effect is obvious to Milne customers. If one animal confidently heads off down a track and the rest of the herd follows, that’s the herd effect. Is there better feed down that track or a cliff face? Same applies with the market. If everyone else is selling via pools this year, there must be a good reason, surely? If everyone is quitting their flock, then wouldn’t it be wise to follow? There is merit to this thinking in that more heads are better than one. But that only applies if all those heads are actually thinking. Markets often overshoot the fundamentals due to the herd effect as sellers or buyers get sucked along by the vortex. Sometimes being the one person that is not quitting their stock works, as the herd changes the context and there will be more feed available for the few that hold on. In that case, the contrarian wins.

Gamblers. Ever seen a coin flip land heads five times in a row and you just know the next flip is more likely to be heads as it's due? That’s known as the Gambler’s fallacy. It's still 50% likely irrespective of previous flips. Same applies with pricing. Things will revert to the average – but only if the fundamentals behind the average don’t change and with markets, that is a real possibility. Lupin production used to be only behind wheat and barley in WA. Now they are behind canola and oats too.

Winners. This comes from anyone thinking that they got a good deal and they have played the market well. It’s worth remembering that the definition of market is that a buyer and seller have to meet on price. That is, both parties must think it’s a fair deal. For you to beat the market and win, someone else must lose. More often than not, there is no winner or loser, it’s a mutual draw. The market is the market after all. The only thing that matters is whether the price obtained works with your business model – not that you have to win an arbitrary contest and chalk up a win on the bedhead.  

This is just some of the psychology behind markets – humans are complex animals after all. Play the odds wisely and maybe you will be an above average market animal!