The market teaches a new lesson everyday. Yesterdays action caught many by surprise. Over the years I have learned my lessons in speculation by getting caught in such moves. Now experience has taught me to be ever vigilant on the market and always to keep market lessons in mind for future use.
All successful speculators know that the markets have a strong tendency to mean revert. The only problem is on day to day basis many forget the lesson. It is the nature of the market that bearish view point sound very appealing when the market is going down, because the market action seems to be reinforcing the bear case. Just when you begin to become a trend follower, the central tendency of the market reasserts.
Why does the market behave in such manner. The best explanation of it I have found so far is in the book Mechanical Trading Systems : Pairing Trader Psychology with Technical Analysis by Richard L. Weissman.
" I believe equity indices tend to exhibit intermediate term choppiness as a function of the dynamic among three separate groups of participants.
- large short term speculators
- institutional momentum followers
- smaller, undecapitalised momentum followers
Typically the interplay among the group is one in which the large short term speculators and institutional players push the market to new highs or lows.
At this point smaller undercapitalised momentum followers initiate new position in to these market extremes as large short term speculators take profit and fade the breakout.
This in turn lead to capitulation of small speculators and weaker institutional momentum followers. Such capitulation usually results in quick, sharp retracement following breakouts prior to dominant trends reasserts."
Mechanical Trading Systems : Pairing Trader Psychology with Technical Analysis by Richard L. Weissman
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