Well here is my Sunday morning thoughts. Please keep in mind that the kids got me up wayyy to early, which has given me far too much time to ponder the state of the universe.
I thought it would be prudent at this time to look at the most negative scenario possible (not necessarily to short term traders, but to the overall market). We're all trying to answer the same question as to whether a bottom is almost there, or whether that this is the beginning of something substantially worse. After thinking about this question, I have to come to the overall conclusion that it actually may very well be the beginning of something worse.
Again, for the the short term trader, this may not matter, so if you read on, do so at your own choosing! These comments are really to be put in the context of the overall broader market, but could have bearing on how we shape our own psychology to do our daily battles.
So here are my thoughts looking at a possible worst case scenario:
As a short term trader, one of the market truisms over the past couple of years was "buy the dips". This was based on the thought that these dips were just natural market occurances on the way to higher highs, and so far this guiding thought has always been true. I noticed a distinct shift this week though working in my own shorter timeframes. The mantra "buy the dips" has now appeared to change into "sell the rallies", representing the first of several psychological shifts to come in the market.
STAGE ONE: THE BOUNCE AND THE THUD
1) So far the markets have been used to dips, but there has always been the bounce.....until the past week. Market professionals, upon seeing the lack of a bounce started going much heavier to cash, particularly on Thursday and Friday of this week, accounting for some of this initial downdraft on the major market indicies that we've now seen.
2) The second 1/2 of this initial downdraft I attribute to people who are in the market but heavily on credit. Margin calls are beginning to take their effect as these people "receive the call" from their brokers. As well, there will (and has been) selling from those whose have bought on credit in other forms (borrowed money from banks etc). They have already taken a hit, and because they are more "sensitive" in the market given that they are playing with borrowed money, they are also more prone to sell in a hurry. (In the midst of a bad scenario, this selling at this point may actually prove to be one silver lining for them, saving them from an even greater fall.)
So who is still in the market? Who are the "bagholders"? The masses. And this is particularly scary I think. First, I believe that through the proliferation of mutual funds, they now represent the biggest collective force in the market. To be sure, it is through their non stop money coming into these funds that the market has had this incredible run in the past 10 years in the first place. Many fund managers have been in a "forced buying" position I believe over the past 10 years, with a large inflow of money coming into the markets and them having to buy whether they thought the overall market made sense or not. Has their been a flood of redemptions yet? Personally, I don't think so. (They don't call them bagholders for nothing!) But if and when the masses decide to move, the potential is there for something far more serious than we have seen so far.
STAGE TWO: THE MASSES BECOME AWARE
So far the masses have been taught to ride out the downside fluctuations in the market...that they would pass and we would be on to greater heights. In particular, this mantra has been preached strongly to the masses over the past 3 years by fund managers and analysts and has become part of their collective psychology. So far it has worked for them, only making them now more prone at this point. With the correction that has taken place this past week though, I believe that this collective psychology will be now be broken. The masses will see that in fact there is no bounce, and that "it IS different this time".
STAGE THREE: SUPER NOVA'S and BLACK HOLES
I think at this point the analogy to astrophysics may just apply. As stars go to Super Nova's they eventually become a victim of their own "success". So much bigger than they were ever meant to be, these suns eventually begin to implode under their own crushing weight. Even at a point where they are "back to normal size", the implosion continues far past what seems to make sense, eventually creating something that no one thought was possible, but which "had to happen", the black hole.
As this theory applies to the markets:
3) As the masses finally gain an awareness of the change that has taken place and decide to go defensive, there will be a flood of redemptions from the mutual funds causing a much steeper downdraft in the markets. As I said earlier I believe these funds now control the direction of the market, up or down, through the collective "wisdom" of the masses. The managers may "drive the bus", but the masses "provide the fuel". This flood of redemptions will cause a much steeper downdraft, and in quick order dismantle the collective resolve of the masses that there will be a bounce. This will finally lead to one final and far more crushing wave of redemptions as a sense of panic finally grips the masses.
So how long will this collapse take? Again, the analogy to the lifecycle of a sun is possibly applicable here. The during of time that a sun builds to its supernova stage is significantly longer than the process of going from supernova to black hole. Particularly in our age of instant communications, I believe that this process will be much swifter and more devastating than would have been thought possible. Add in to this that much of the money (people) in mutual funds came in after the 87 crash and have not sustained any real personal pain. They may be more prone to panic once they see what it really happening.
What does all this doom and gloom scenario mean to a technical trader? I think it means the "usual" rules we make our decisions nay not apply as well and that our own mental adjust is at least temporarily in order. Areas that we "expect" to act as support won't. We will go through these levels with increasing ease and urgency. We are already seeing this starting to happen on the Nasdaq as a number of short term "support zones" have been broken, and then worse, having these zones return only to act as resistance points as people sell into the rallies.
Now as I said before, to a short term technical trader all the above doesn't really matter too much. Money can be made on the upside or the downside. However it is prudent to trade with the overall trend in mind as it would be so easy (even at this point) to wade foolishly in the to market now saying "this stock is just SUCH a bargain....it just has to bounce!" (How many of us did this on RIM earlier this week? uggh!) Perhaps with the above scenario now in mind, today's "bargains" will be tomorrow's "fire sales".
Personally, I hope the above scenario doesn't play out. A lot of nice people would sustain severe financial damage. My hope is its just the silly ramblings of a guy who's time would be better spent getting out of his housecoat on this early Sunday morning and on with the more important things of the day. ....which is not a bad idea at this point actually. I'm out to play with the kids. :)
Regards,
Kevin |
