"An abnormal reaction to an abnormal situation is normal behavior."
-- Viktor E. Frankl
As we head into the three-day weekend, the indices are up six days in a row and hitting all-time highs. Ironically, such strong action tempts many market players to be negative. The logic is that the market has gone up too far, too fast and the move isn't even justified, so let's bet on a correction.
Logic of that sort is understandable, but it assumes that the market thinks in the same manner as a normal human being. We generally assume that people act in a reasonable manner. There are many examples in behavioral economics that prove that people don't always act in the most rational manner, but we still like to project human qualities on to the stock market.
The stock market is not a rational human being, and it shouldn't be treated as such. To effectively navigate the stock market, it is important to understand that it operates differently than the human mind. Concepts such as reasonableness or excessiveness are corrupted by the pressures created by the crowd mentality. Traders, especially the computerized versions, are always looking for a way to manipulate and navigate the desires and emotions of other traders, and that results in behavior that isn't very normal or predictable.
Just because it seems very reasonable that the market needs a rest doesn't mean it will happen. The indices have gone straight up for six days in a classic V-shaped action. Volume has been mediocre at best and now we have a three-day weekend beckoning. What would a rational human being do in such a situation? Take some profits. Is there any other logical choice?
It would be pretty easy if the market thought in that manner, but that isn't the case. Instead, the traders that are sitting around drinking their morning coffee and reading the news flow are thinking how they are going to take advantage of those poor schlubs that are using such simplistic logic.
The first thing the sophisticated trader is going to do is to look to take the other side of the trade. If the rational, individual trader is selling, then we are buying, and are going to keep this market up. That will drive some short covering and chasing and then we can flip the shares we bought at a higher price.
The logic quickly becomes more complex than that, but it illustrates why we shouldn't project human qualities on to the stock market. The stock market is not at all similar to a normal human being.
My game plan today is to keep this idea in mind as I watch the action. Personally, I would like to see some selling on a strong pullback, as it would create some easier opportunities. However, the very fact that I'm wishful for downside means I have to be better prepared for it to not occur. If the market doesn't pull back like I hope, what steps do I take to make some money? I better find the right stocks to trade.
In the early going, there are some indications that the market is going to rest, but it is very likely that the dip buyers are prepared to pounce. Volume will be light today and that makes it even easier for the computerized traders to manipulate the action.
A pullback here makes sense, but it is probably too simple and easy.
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