5 charts to tell if stock buyers are too bullish

http://www.marketwatch.com/story/5-charts-to-tell-if-stock-buyers-are-too-bullish-2013-06-17

The cycle of market emotions

Feelings. Nothing more than feelings. That about sums up the stock market on any trading day.

Investment return and risk are joined at the gut. No pain, no gain, and, above all, no free lunch. Ideally we’d all approach investing with a cool hand and a poker face. But people being people, emotions get in our way — especially when real money is at stake and headlines and talking heads scream “buy” or “sell.”

There’s no escaping the cycle of market emotions — that roller-coaster ride from optimism to despair and back. But understanding where we are on this track can keep you from going off the rails and even lead to well-timed gains. Sentiment charts are popular on Wall Street — passed around to spur debate about where stocks might be headed next. Here’s a look at ways to decipher the market’s moods.

— Jonathan Burton

Professional wrestling

Money managers court too much career risk if they miss the benchmark return, which encourages many pros to follow the herd and aim for results just enough above the market average to justify their fees.

Accordingly, pay attention to the portfolio manager strategy cycle. Notice that as panic and desperation take hold, the sharpest pros go against the crowd with short-selling and other bearish tactics.

And as all of these charts show, the optimal time to buy stocks is in the aftermath of a market crash.

Easier said than done. But at the point of maximum pessimism, when everyone is convinced that the time-tested buy-and-hold strategy is dead, smart investors wade in carefully, staying nimble and executing selective, calculated trades. Once optimism returns and investors are again comfortable with stocks, a sentiment-sensitive investor will recognize that it’s about time to be contrarian.

Buy, sell or panic

On most sentiment charts, “denial” appears as market conditions deteriorate. No one wants to admit the good times could be over, so they refuse to see the truth.

But denial is also powerful as stocks climb that proverbial “wall of worry,” as this insightful chart aptly notes.

Indeed, losses work both ways. Overconfidence can trap you in a declining market, while anxiety can shut you out as prices rise. Current market conditions are a prime example. This has been called the most hated bull market in memory. U.S. stocks’ powerful advance since March 2009 has been discounted, dismissed and discredited every step of the way to record highs.

Also important: Be aware of the “subtle warning” the market registers in the wake of peak enthusiasm. Above all, heed the “overt warning” when key support levels are breached.

The No. 1 enemy at such times: Disbelief — not trusting your intuition, instinct and available information.

Timing isn’t everything

Short-term traders and speculators put up a good front. They appear to know when to get in and out of the market, but in truth they’re as subject to emotional upheaval as anyone else — maybe more so given their peripatetic nature.

“Fear and greed are stronger than long-term resolve,” former Wall Street strategist Bob Farrell famously noted in his 10 Market Rules to Remember.

Indeed, one advantage individual investors have over high-frequency traders is time. Let the algorithm acolytes try their best to time the market; for the rest of us, time in the market is what counts.

Hope and hype

So, where are we now? Clearly not the “Stealth Phase” — that was so 2009. Probably the U.S. market is in an era of “enthusiasm” — that time following the “media attention” when the general public buys in to what the “smart money” and institutional investors already know. Yes, there are moments of “greed” and “delusion,” but nothing to tip the scale — yet.

Too bad this benign period also marks the buildup of the “Mania Phase,” which never ends happily for investors who not only aren’t prepared to change their game plan — they don’t even have one. Instead, they convince themselves that “it’s different this time.” It isn’t.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s