André Kostolany and the Egg Model

Why do stock prices rise and fall? Sometimes a company's stock price increases after it reports strong earnings. Other times, stock prices decline when the economy weakens. However, stock prices can also change dramatically even when nothing significant has happened to the companies themselves. To understand why, we need to look not only at company performance but also at the psychology of investors. André Kostolany was an investor who placed great importance on investor psychology. Born in Hungary in 1906, he spent much of his life working in European financial markets as an investor and writer. He experienced numerous market booms and crashes before his death in 1999 and shared what he learned through several books. Kostolany recognized that the stock market does not move in one direction forever. Periods of rising prices are followed by periods of falling prices, and excessive optimism can eventually turn into pessimism. He illustrated these movements using an oval-shaped diagram resembling an egg. This became known as Kostolany's Egg Model. The Egg Model divides stock market movements into two broad periods: rising markets and falling markets. The rising period is divided into three stages, labeled A1, A2, and A3. The falling period is divided into three stages, labeled B1, B2, and B3. The bottom of the egg represents a period of low stock prices, while the top represents a period of high stock prices. According to the model, the market moves up one side of the egg and down the other in a repeating cycle. Imagine that the stock market has been declining for a long time. Many investors have suffered losses, and people are afraid to invest in stocks. News reports frequently describe economic difficulties, and fewer people show interest in the stock market. However, some investors begin to believe that stock prices have fallen too far and gradually start buying shares. This marks the beginning of stage A1. Relatively few people are trading stocks, and even when prices begin to recover, most investors believe the increase is temporary. Nevertheless, as stocks recover from excessively low prices, the market gradually begins to rise. The next stage is A2. Economic conditions improve, and companies begin reporting stronger earnings, providing more reasons for stock prices to rise. More people become interested in investing, and trading volume increases. Trading volume refers to the number of shares bought and sold during a particular period. Although stock prices may occasionally fall during this stage, the overall market trend is upward. If the market continues rising for a long time, it may enter stage A3. Stories about investors making large amounts of money become widespread, and even people who previously had little interest in investing begin buying stocks. Investors become more concerned about how much higher prices might rise than about the actual value of the companies. Even when warnings suggest that stocks are becoming expensive, expectations of further gains continue to grow. Kostolany described this as the exaggeration phase. Excessive optimism and investment enthusiasm can push stock prices far above the underlying value of companies. However, the number of people willing to buy stocks cannot increase forever. Eventually, when new buying activity weakens, stock prices may stop rising. The market then passes the top of the egg and enters a declining period. The first stage is B1. Stock prices begin to fall, but many investors believe the decline is only a temporary correction. Some investors start selling their shares at relatively high prices, and trading volume tends to decrease. Nevertheless, many people still expect the market to recover. As the decline continues, the market enters stage B2. Negative economic news becomes more common, and investors grow increasingly concerned about falling prices. More people sell their stocks to avoid further losses, sometimes causing trading activity to increase. Meanwhile, the number of investors willing to hold stocks continues to decline. The optimism that once dominated the market gradually turns into pessimism. The final stage is B3. The stock market has fallen significantly, and fear among investors becomes extreme. Trading volume may surge as large numbers of investors rush to sell their shares to avoid additional losses. When many people want to sell regardless of a company's actual value, stock prices can fall excessively. However, some investors see this situation as a new opportunity. If a company's future prospects remain reasonable but its stock price has fallen too far because of widespread fear, its shares may be available at an attractive price. As buying activity returns and market sentiment changes, the market may eventually move back into stage A1. Kostolany also divided investors into two broad groups. One group consisted of investors who followed the actions of others, while the other consisted of investors who made decisions based on their own judgment. Investors who follow the crowd tend to buy stocks after prices have already risen substantially and sell them when prices fall sharply because they become afraid. Independent-minded investors, by contrast, look for opportunities when the market becomes excessively pessimistic and act cautiously when optimism becomes extreme. Based on these ideas, Kostolany suggested considering purchases during stages A1 and B3 and considering sales during stages A3 and B1. During stage A2, his approach emphasized holding stocks and waiting, while during stage B2, he favored holding cash and observing the market. The general idea was to become cautious when almost everyone wanted to buy stocks and to look for opportunities when almost everyone wanted to sell. Does this mean the Egg Model can help investors make money every time? Not necessarily. In reality, it is extremely difficult to determine exactly which stage the stock market is in. Prices may continue falling even when stocks already appear cheap, and stocks that seem excessively expensive may continue rising for a long time. Furthermore, not every company's stock follows the same pattern. Some companies continue growing even when the overall market declines. Others may experience falling stock prices because of poor management or declining business performance, even during a strong market. Corporate earnings, interest rates, economic conditions, new technologies, and investor expectations can all influence stock prices. Today, the Egg Model is sometimes explained in connection with changing interest rates. For example, bank deposits may become more attractive when interest rates are high, bond prices may rise when interest rates fall, and lower borrowing costs may encourage investment in real estate and stocks. However, the version of the model that describes shifting investments among bank deposits, bonds, real estate, and stocks is a later interpretation that expands upon Kostolany's original framework. Ultimately, the most important lesson of the Egg Model is not that investors can predict exactly when stock prices will rise or fall. Rather, it demonstrates that stock markets are influenced not only by economic conditions but also by people's expectations and fears. Investors do not need to buy stocks simply because everyone else is buying them. Likewise, they do not necessarily need to sell their investments just because many other people are selling. What matters is examining a company's underlying value and future prospects and making decisions based on independent judgment. This was one of the central lessons Kostolany sought to communicate through his Egg Model. Market sentiment constantly changes, but the ability to think independently rather than follow the crowd remains important in every market environment.