Commentary: Stay atop the cycle and don’t get gored by the herd
By Michael Sincere and Pascal Willain
BOCA RATON, Fla. (MarketWatch) — Like the hapless souls who boldly race bulls through the streets of Pamplona, Spain, unsuspecting people charge down Wall Street without fully appreciating its unpredictable and dangerous terrain. Although eager to participate, many end up getting gored by the herd.
In fact, one of the most popular contrarian methods of beating the market is doing the opposite of the herd: buy when there’s blood in the street, or sell when the crowd is celebrating.
Since we’re always fascinated by what the crowds are thinking, we created our own version of the Investor Sentiment Survey (Justin Mamis created an original version back in the 1990s).
The idea is if you can identify what the majority of investors are feeling, you could get clues to where the market is headed next.
Investor sentiment cycle
Last week, Charles Kirk, owner of The Kirk Report, sent a questionnaire to 100 professional traders based on another version of the sentiment cycle.
According to the results of Kirk’s informal poll, most of the pros who responded think we’re at a crucial crossroads in the market: 37% believe investors are in denial or fear, which could set the stage for a nasty fall. And 63% believe that we’ve bottomed out, which could turn into a monster rally.
The most probable is we’re in the “disbelief” stage, especially if we continue to move higher this week.
Several of our favorite market indicators also have generated buy signals. For example, the S&P 500 (CME:INDEX:SPX) crossed its 200-day moving average into positive territory. In addition, MACD crossed its signal line, another positive sign.
And yet, although many technicians acknowledge the positive signals, several appear suspicious of this latest rally. They just don’t seem convinced this is the real deal, suggesting that the market could be in a trading range, and not a bull market. Adding to the bull side, however, the National Bureau of Economic Research claims the 18-month slump, the longest recession since the Great Depression, has ended.
On the other hand, sentiment surveys are turning much more positive, suggesting that you may want to do the opposite. For example, the latest reading of Investors Intelligence and the AAII Sentiment Survey are leaning towards the bullish side. If these surveys surpass 60% in either direction, this can be a deadly accurate contrarian indicator. As the market moves higher, and as people get more bullish, a reversal could be in the making.
Everything seems so positive that we’re wondering if the market has a trick or two waiting for us in time for Halloween. Because we’re prepared for anything, including a really frightening prospect, we created a third market cycle, the Doomsday Scenario. It could play out something like the scenario in the chart below:
Right now, the market is doing the opposite of what many people expect. Some have thrown up their hands in frustration and won’t look. The cruelest cut of all would be a never-ending tug-of-war between the bulls and the bears, with no clear winner.
And yet, old-time market watchers say they have never seen a market quite like this. Some blame it on the “flash crash,” which was the first hint some strange stuff was going on behind the scenes. This isn’t their father’s stock market.
We don’t claim to have definitive answers of where this conflicted market is going next. All we can do is point to the signals so you can make up your mind what to do. We will leave you with this suggestion:
If you want to avoid getting gored by the herd, you may have to sit and patiently wait for opportunities. Jesse Livermore gave this advice in Reminiscences of a Stock Operator: “After spending many years in Wall Street and after making and losing millions of dollars, I want to tell you this: It never was my thinking that made the big money for me. It was always my sitting. Got that? My sitting tight!”
But while you’re sitting tight, don’t ever forget what Sergeant Phil Esterhaus, from the hit television series, Hill Street Blues, said to the cops and detectives at roll call: “Hey, let’s be careful out there.”
Michael Sincere is the author of All About Market Indicators (McGraw-Hill, 2010) and Understanding Options(McGraw-Hill, 2006). Pascal Willain is the author of Value in Time: Better Trading through Effective Volume (Wiley Trading, 2008) and owner of the website, www.effectivevolume.com.
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