Consolidation versus Crash

Markets yesterday were set up for a major disruption: New quarter, earnings season, a blistering Q1 and an overbought condition. What we got instead was a low volume, 1% correction.

Whenever we are at an important market junction, I like to wargame a few scenarios:

• What would the markets be doing if this was a major top? How would trade progress, what would the internals look, what sort of sentiment conditions would we have?

• If this were a modest correction or consolidation, what characteristics should/would that have?

What do you see when you look at the markets during yesterday’s selloff? Lower than average volume on SPY, a big drop off in Nasdaq volume, an uptick in VIX, 5 to 1 Decliners versus Advancers, 3 to 1 new Lows vs Highs, 8 to 1 on declining versus advancing volume. Markets rallied back from their lows, closing significantly off their intraday bottoms. Some significant charts do show some trendlines breaking (or close to it).

To me, that looks more like what I would imagine a consolidation should look like, and less like what the start of crash might be.


Funny, following the Bears Need to Put Up or Shut Up post, I have been getting into some odd conversations with traders (and ex-traders). Yesterday, I got into it about the nature of trading versus investing with someone Paul Kedrosky calls “a prattling gasbag of idiocy.” As far as I can tell, this person has been Bearish for about six months, and was pounding his chest about avoiding a 1% decline — after missing the 24% rally since October 2011.

It was as extreme a case of confirmation bias as I had ever seen.

And that is my personal nightmare. I spend a lot of time looking for opinions contrary to my own, forcing myself to read a different views to specifically avoid that sort of bias. Sometimes its painful to fight my way through them (Thank goodness for Dougie — he makes reading an opposing point of view a pleasure).

We are all subject to Human biases, cognitive fallacies and investing errors which make investing such a challenge. We can try to be enlightened about these negative tendencies, hardwired though they are into our very nature, and overcome them. But without even an awareness of these limitations, our investing is doomed.

What are you doing about your own inherent biases?

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