John Reese, editor of Validea, assesses stocks based on the known investing criteria of many of the ...
Learning to Live with Mania and Greed in the Markets
08/21/2009 10:49 am EST
The market continues its upward and downward trek and it often seems that either way, the talk is all about if we have moved too far too fast. I read a short article (actually, just the headline) a while back and it said, “Even the most optimistic are fearful we have moved too far too fast.” We know the market moves in cycles and we want to catch those repetitive cycles that will help us profit. We break these cycles down into four stages. After studying this and learning how to read the four stages correctly, most have found that they can attribute over 80% of their losses to being on the wrong side of these stages during their trades and investments.
The market will always move further than we expect up or down. You have heard the phrase “The Trend Is Your Friend,” and that is going to always be the case. The market will always outlast any of our capital accounts if we are on the wrong side and our opinion does not matter. The only opinion that matters is that of where the money is flowing. I thought it would be fun this week to talk about fear and greed, which is critical to recognize properly from reading charts so you are on the right side of your investments and trades. Today, I want to talk more about the greed side. I don’t want to mislead you to think we are in the midst of a “Tulip Mania,” as we are not, but you will understand why I wanted to talk about this as you read through this. Enjoy!
The Tulip Mania and Traders
All Pristine traders know that we trade people, not stocks, as their responses to events and fear and greed that move stock prices. Thus, we urge traders to not only master Pristine technical analysis, but to embroil themselves in studies involving risk management, psychology, and crowd behavior. Although certain "events" change over time, human nature never does.
As discussed in Martin Friedson's book, Extraordinary Popular Delusions and the Madness of Crowds, the tulip, a Turkish word signifying a turban, was introduced into Western Europe about the middle of the sixteenth century. Allegedly first seen in 1559 in a garden at Augsburg, tulip bulbs were sought after by the wealthy, especially in Holland and Germany, where they paid extravagant prices for them. The rage for possessing them soon caught on among the middle class. One trader was known to pay half his fortune for a single root, not with the intent of reselling it, but to keep it for self-admiring. Another gave 12 acres of land for a Harlaem tulip. And this occurred despite many recognizing that the tulip neither had the beauty, smell, or endurance as the rose.
Just like stock traders, the tulip jobbers speculated in the rise and fall of the tulip stocks, making large profits by buying low and selling high. The operations of the trade became so extensive and intricate that it was found necessary to draw up a code of laws for the guidance of the dealers. As the more prudent began to see overvalue, they stopped buying them, confidence was destroyed, and a universal panic seized the dealers when buyers (the "bid") ran for the hills. It eventually busted.
In February 1637, as spring drew near and the bulbs were close to flowering, consumer confidence evaporated and the market suddenly crashed. As the price structure collapsed, Friedson reported that "Hundreds who, a few months previously, had begun to doubt that there was such a thing as poverty in the land, suddenly found themselves the possessors of a few bulbs, which nobody would buy, even though they offered them at one quarter of the sums they had paid.” Litigation ensued, and a government commission ruled in May 1638 that tulip contracts could be annulled upon the payment of 3.5% of the agreed price.
History shows that these mass "manias" of speculative frenzies reoccur time and time again. Here are some other manias of the century that all rose and busted during the decade in similar fashions:
1890 - Railroads
1910 - Buggy makers and cigar stores
1920 - Radio & phonograph
1950 - Bowling chains
1960 - Conglomerates
1970 - Nifty Fifty, oil and gold stocks
1980 - Junk bond promoters, REITs, Japanese stocks, PCs, pharmaceuticals
1990 - Biotechs, telecommunications, and Internet
2006 - Residential homes
2008 - Oil, gold, agriculture, and other mini-speculative sectors
Each time, the public argued that the particular "fad" was different, somehow trying to distinguish the prior manias as obvious nonsense that would lead to extinction. But to lesser extents, these "mini bubbles," particularly in sub-sectors or stocks of particular interest, frequently occur, giving us tradable opportunities. For example, when the Nasdaq began tanking in 2000 - 2001, tremendous rallies occurred in gold, commodities, housing, and military sectors, despite the broader market weakness. Assume in 2010, flying cars and personal space suits are invented. Will the public drive their stock prices to unsustainable levels saying "It's the real thing, baby," again dismissing the prior bubbles as rampant speculations destined to the graveyard?
Or will history repeat itself… again? And will you be ready?
We who know how to read these cycles properly know how to exploit the moves that occur daily. These cycles and opportunities abound on a regular, routine basis and once you finally realize that you don’t need all of those 170 indicators on your charts, and just knowing how to read the market (people), you’re trading and investing will improve by leaps and bounds.
Until we meet up again, stay safe and remember: No one is making you trade. So, only take trades and investments that line up with the highest probabilities that fit into your specific plan!
By Ron Wagner
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