Last week I talked about three ways a market can move (up, down or sideways). This week I want to talk about bull and bear traps. There is a concept on Wall Street known as a bull (or bear) trap. The idea is simple, in a bull market there are big shakeouts (pullbacks/corrections) that occur which are normal and healthy but shake out the weaker hands. Then cooler heads prevail and the market (or stock) hits new highs shortly thereafter. In downtrends (bear markets) the opposite is true. We tend to see steep downtrends followed by steep counter trend rallies, then we see new lows again.
Largest Rallies In History Occur In Downtrends
Be very careful right now because if this is the start of a new downtrend (More evidence is still needed and it all depends on what happens with QE) then you will see several large “big rallies” that seem very strong and attractive but they will be followed by new lows shortly thereafter. That is the nature of markets (reflection of human nature) and this phenomenon will continue to play out as long as human’s continue to trade stocks. Also keep in mind that the largest rallies in history tend to occur during bear markets (not bull markets) for this exact reason. So be very careful to avoid getting whipsawed in and out of markets/stocks during volatile times.
Stocks Are Counter Intuitive In Nature
It is also important to keep in mind that the “obvious” rarely works on Wall Street. Bull markets begin when pessimism is rampant (think March 2009) and ends when euphoria is palpable. Conversely, bear markets begin when euphoria is palpable and end when pessimism is rampant. Right now we are leaning more towards the euphoria side of the equation but we are not quite there yet. Since 2000, we have seen two vicious bear markets which caused material damage on the market’s psyche. It will take a lot of time for the psychological damage to heal. Last week was another example of how markets are counter intuitive in nature. Just when everything looked awful and it looked like we were going to crash, BOOM- the bulls showed up and sent stocks sharply higher. That is a very strong sign of institutional accumulation (institutional buying) and suggests the bulls have not breathed their last breath just yet.
