Corrections and psychology

Corrections and psychology

December 1, 2006

What we are witnessing currently is a correction after a 4-6 month rally, which did not have a meaningful correction along the way. If you are unprepared for a correction and caught by surprise, the devastation caused to your account in few days clouds your thinking. I know this well, as I have been there before. After few hits like that in early trading career now I have become better at anticipating these things.

The psychological impact of a sudden correction can completely devastate you and can lead you to missing the next part of the move. once bitten twice shy, you can be slow to react to new market opportunities. Plus the bearish side and bearish logic always sounds very alluring and seductive at such stage. There is a chorus of bears out proclaiming end to the rally and as usual painting their sky is falling rhetoric. You can listen to them and join the dark forces and become an active card carrying member of the bearish cult, or you can spend the time to research new opportunities, perfect trading system, do R&D and get ready for the next phase.

Economic data releases are about hind sight and often the economy slows down to a crawl and then accelerates again, which gets reflected in new data set. You also need to keep in perspective bearish calls by bond Gurus like PIMCO’s Bill Gross, he had called for DOW 5000 in September 2002. Lot of time he is just talking up his position. The bond market is not necessarily the best indicator all the time.

Also keep in mind that interest rates are low by historic standards. Earnings have been at double digit. The earning season is over, the market rallied in anticipation of good earnings and was right about it. So till next earnings it might spend time going nowhere and sideways and make a move closer to next earning season. Corrections in bull markets are always sudden and scary.

Always be willing to look at alternative bullish hypothesis. If the market breakout post a correction, watch out, you will get to eat lot of delicious bear meat for long time to come.