Market Games

Bull markets last long enough to erase the memory of most market participants of how it feels to be in a correction and what should be done.

Back in January this year, most people disbelieved the rally and were very cautious. The second half of 2011 was the definition of a trendless, high-volatility, choppy environment and over time it conditioned most of us to be very nimble and take profits quickly. Most breakouts failed, mean-reversion from overbought and oversold reading worked almost flawlessly.

As the bull market climbed a wall of worry, more and more people started to figure out that breakouts are actually working and delivering solid results.

In bull markets, corrections happen under the surface and take the form of  sector rotation. When financials and tech took a breather, biotech and consumer discretionary took the leading role and the indexes barely budged. All dips were a great buying opportunity in hindsight. Somewhere along the way, people realized that instead of jumping from a setup to setup, they might be much better off just riding three or four strong stocks.

The market has been really accommodating in the first 3 months of the year, to a point that it created complacency. Naturally, when a shift in a character came, most people were slow to react.

We entered a choppy, high volatile environment, where many breakouts will be short-lived. We will see stretches of several red days followed by a pocket of green days that will continue long enough to confuse everyone.

Recency or our tendency to  pay enormous attention to the most recent price action has huge influence on our psychology. A few red days in a row and everyone turns bearish and give up positions bought on a dip, just before the market is ready to bounce. A few green days and everyone thinks that all is well and new highs are on the horizon. Don’t judge the market based on one day of market action.

Trednless markets could be very stressful to those who don’t notice the change of market character and rethink their tactics.  Stress leads to overtrading and the latter is a really dangerous endeavor in a choppy market environment. Overtrading leads to losses and losses lead to a loss of confidence, which is the last thing you want to happen to you, because your decisions will be ruled by fear and not rules.

Greed and fear often trump experience. The choices we make every day define the quality of our  lives. We are in the business to make money, not to make trades.

Choose wisely. Do less.

Market Noise or Why Recency Bias Hurt Us

In life, there is no second chance for a first impression. First impressions are the most memorable and have the biggest impact on our thought process. They subconsciously form prejudices and mental shortcuts that define our behavior.

The trading world is different. It is an environment, where last impression is often the strongest and has the biggest impact on decision making. We put tremendous weight on the short-term price action, while it often represents just noise. Because it’s easier, we’re inclined to use our recent experience as the baseline for what will happen in the future. We project the most recent events into eternity and make unwise decisions.

We strive to know everything about everything and make sense out of every move, even when it is a garden variety of noise. Sometimes we forget to take a step back and see the big picture. Zooming out helps to curb the frustration and clear the head.

If you intend to be in this business long time, you have to find a hassle-free way to manage your portfolio. Howard Lindzon has found it by focusing on longer-term social and business trends that are confirmed by price action. Brian Shannon has found it by focusing on day trade setups and being 100% in cash at the end of the day. Joe Fahmy has found it by timing his market exposure and swing-trading stocks with solid technicals and fundamentals. There are different paths to achieve the same goal.

Not everyone is willing to put the time and the efforts needed to define himself and focus on a specific approach. One of the lines from the original Market Wizards book that has remained vividly in my head comes from Ed Seycota. On the question, what would you recommend to the average trader, he replies: “Find a superior trader to manage his money for him and then find something he loves to do.” The trouble is that it is much harder to find a superior trader who will want to manage your money than to learn how to be consistently profitable yourself. Just because someone sounds confident, doesn”t meant that he will be able to deliver.


The Spike In Gold Is Not a Good Sign for the Stock Market

Gold gaining ground today has nothing to do with rising inflation expectations. On the contrary, it is quite the opposite. Spain’s 10 year  yield is climbing again. Swiss, German and U.S. Treasuries are rallying. There is only one explanation behind the rally in $GLD – it is currently playing the role of a “safe” asset in a “risk-off” environment.

The U.S. stock market is oversold on various measures, which doesn’t mean that it can’t become more oversold as nothing brings fear as fast declining prices. The silver lining of this correction is that we are entering earnings season with reduced expectations, which has usually been a good predisposition for positive surprises.

Even if there is a short-term bounce coming, we have entered a period of choppiness, where mean-reversion trades are likely to work better than breakouts.

$GLD rallying with $TLT is bearish for stocks. Once you see gold selling off along with the equity market, then we would be much closer to a “forced liquidation” period, which has historically provided great entries for long-term investors.

JPMorgan ($JPM) and Wells Fargo($WFC) report this Friday and the reaction to their earnings will reveal a lot about the near-term future of the stock market.