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The Great Manic Depressive: The Markets

The markets are a lot like a manic depressive in that there are moments of incredible euphoria and then, almost in the blink of an eye, incredible feelings of despair and hopelessness. These emotional extremes are also contagious to those who are participating in the markets and as individuals suffer these extremes they eventually reach a point where they are paralyzed into inaction just as the markets begin to turn in their favor or detriment.

When the markets are healthy and the future for the economy looks bright the market is incredibly euphoric and like a manic depressive experiences incredible highs in emotional well-being that often result in caution being thrown away while riding the incredible sense of euphoria as the markets rise ever higher. Unfortunately, as night follows day, markets will eventually go down but the investors swept up in such a strong emotion as euphoria feel too connected to its source (the market rising) to ever consider that it may be time to lock in gains or protect a position. They are blind, like addicts that cannot admit their addictions they cannot admit that now is the time to leave the market for that has become there drug of choice.

After awhile, however, as the emotional high subsides in the market and suddenly it crashes as it discounts the future of the economy which faces a slow down or recession which causes an ever increasing sense of despair and hopelessness among the investors as they hold on during every decline and hope thru every short term rally only to feel there emotional well-being crash lower as the decline continues. The markets become more and more depressed to the point of no return for the investing faithful who have been bleeding losses since the crash and, in there final act of their investing death thro, they liquidate their holdings for a fraction of what those holdings were once worth.

The last of these sellers often result in a climatic sell off resulting in sharp move down in the markets as a violent convulsion down squeezes out the last of the investors that had been holding on. The market stands at the abyss on death’s knell causing much of Wall Street and Main Street to feel the dull pain of impending death of what they have understood to be modern day capitalism. Doom and dread is everywhere….on TV, cable financial news, in the newspapers, in the classrooms, on the cover of magazines, and in every barbershop and hair salon everyone talks of the end of the markets.

Then, as the last of the sellers receive their stocks sell slips a stirring begins again in the markets. Suddenly, volume begins to pick up and a huge rally takes place but is discounted as short-covering by the short sellers. A few days later, another rally takes place on higher volume and again is ignored. New stock leaders begin to see new levels of volume pour into their shares as big institutions and money managers begin to take positions but, still, the individual investors stay away out of fear.

Over the coming months, the pessimism of Wall Street gives way to caution with all the talking heads giving glowing commentary again about the huge prospects for the economy and hot IPO’s (initial public offerings). Institutional money is still pouring into new leaders in the stock market and smaller investors begin to wonder if the rally is for real. Those that do decide they will participate but only when stocks “get a little cheaper” but they never do.

Soon, the new leaders are rocketing higher and higher while investors feel they are missing the boat and begin to buy without noticing that the general market appears to be stalling and coming under distribution. A few weeks later, as investors are now back in the market the market appears to decline again with investors caught in the crosshairs again.

This cycle is played out over and over again as the general market’s manic condition creates an emotional whirl storm that investors get caught up in and allow themselves to become victim to.

Average investors allow themselves to fall victim to this cycle of extremes because they come into the market with no plan or method to trade. They buy on tips from there brother-in-law or because a stock is reputed to be a “good company”. These are not plans or methods they are gambling.

A fundamental key to winning then is to realize that successful trading is counter-intuitive compared to how the general public approaches the markets. Having a method or system that allows you to exploit an advantage helps but, ultimately, even the greatest trading method ever devised helps no one trade successfully if they don’t realize there are certain underlying truths to making big gains in the market that are counter-intuitive to the way most people attempt to win at trading.

Now, that you can see a little how these cycles form and are repeated we will journey together to learn how not to be swept up in a tsunami of negative emotional turmoil due to unnecessary losses by following the crowd and/or our own faulty reasoning in future posts.

8 replies on “The Great Manic Depressive: The Markets”

Maybe I am a sceptic but i always get the feeling that once people get the wind of a possible down-turn in the markets this is fueled by the ‘big boys’. Promoting the ‘downturn’ can surely end up beneficial. Especially if the downturn is indeed unfounded or unwarranted.

The large traders and institutions that carry the most weight can quite easily, I am sure, off-load substantial market holdings thus forcing the market lower.

The panic then starts to set in. The smaller investors do indeed wait, frightened to sell, frightened to hold – in no mans land.

Further selling follows. The small investor panics and then starts to sell.
Followed by thousands of others. The institutions are then in a position to buy stocks back at a low price – large profits to follow and the market/cycle ‘recovery ‘ starts again as the stock ‘recovers’. Having sold at the top of the market and bought again at the bottom it is the small investor that once again takes the flack.

Sounds too simple, but if you have enough clout then most things are possible.

Steve – Billy will no doubt have his own thoughts, but my thinking is quite simply to wonder if the institutions are so powerful and capable of pushing things around, home come most of them can’t beat their benchmarks? We always have to remember that there are people making the investment decisions at these big institutions (even the algo funds have human input into their design). As such, they are just as prone to getting it wrong as an individual.

Steve and John both make interesting points and I find that my own comments are actually a combination of the two.

I happen to think there is some price manipulation in the market, at least to some degree, and I could offer up numerous examples however it takes more than stock manipulation to win at the markets. John’s comments about observing the poor performance of many of the big funds and their failure to beat there benchmarks as the most damning proof of what I write.

Likewise, even if it weren’t true, I am of the opinion that you would still find a small group of traders taking the lion’s share of the profits (Pareto’s Law would still apply). One only has to see the limitations placed on market makers when trading yet they tend to as a group perform better than any group of traders on the floor even without the onerous regulations placed on them by the exchanges.

No, with or without outside forces impacting on the market it still comes down to having a quantified method for trading the markets with all of the various factors involved and, more importantly, a method that factors in the individual itself. A trader reaches greatness in direct correlation to the intrinsic attributes they develop within themselves as well as their craft, in my opinion.

The ability to read price action, manage a trade from entry to exit, adhering to a trading formula or plan, self-discipline, position management, etc. will have more of an impact on your results than whatever the big institions, hedge funds, floor traders, Illuminanti, the Fed, or whatever will have in the end.

I agree – the boom and bust cycle has always proven that what goes up must come down, but even better, what goes down must go up again. There are some interesting insights at a similar website: fisher-investments.typepad.com.

Well in my optinion, history repeats itself, perhaps not identically. Volatility has a lot to do with trading pains and losses especially in the chop. Traders should distance their stops by a volatility function as well as size their trades. I would also add that it is often good to have rules to suspend trading during times of excessive volatility.

All that is needed is the proper quantiative reseach on quality historical data like offered by these guys.. http://www.forextickdata.com and to test your methods during similar times of adversity in the market as well as those in foreign markets as well.

Best to everyone.
David

I have a view that may be seen as a bit out there, but here goes.

I believe history repeats because humans have been unable to evolve emotionally.

We have evolved intellectually but most certainly not emotionally. I read once that attachment is the root cause of all suffering, i.e. when you are attached to a certain outcome.

This is ever so obvious in trading and investing, where a trader/investor is so attached to the outcome, it is little wonder the masses capitulate together

Dean

My question here is in what way(s) have we evolved intellectually?

The point I would make about emotion is that it’s primarily an automatic response, while intellect is not. As such, avoiding or controling emotion is nigh impossible, though we can certainly learn to recognize it and control our responses.

As for attachment and suffering, that’s very much a Buddhist/Zen type of expression.

Here is my take:
History repeats and will repeat since dealing the same situation in different times is different. It is not possible to standardize or define emotional resolution. They are not governed by rules, but intuition – It may be partially controlled at certain times.
Institutions can push and pull things severely, only when the significant small traders are victims of the panic. The more deficiencies in the small traders and their emotional organization, the more powerful are the Big guns.

John

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