July 15th, 2008

Prediction, Clairvoyance or Self-Fulfilling Prophesy?

I wish there were more positive news and ideas to share with you, friends, but there just isn’t. The market is starting to feel like “Chinese water-torture”, a continual slow-drip on the forehead that supposedly ultimately drives its victim insane (for more information you probably ever wanted to learn about something that probably never existed, “Chinese water torture”, see Wikipedia).

In a mere 38 trading days, the market has fallen 13.9%. How did this happen when there have been almost an equal number of up and down days (20 and 18 days respectively)? The answer is that the market has risen an average 0.55% on up-days but fallen -1.23% on down-days.

This recent decline almost matched the -18.44% fall from the October 9 high of 1565.15 to the March 17 low. To repeat, if the current decline continues for another 5 percentage points so that the current decline matches the previous 18.5%, the Index will land on 1166.89, or just about exactly the number I’ve been writing about since February (1150).

But I’m not alone. Many people look at the same charts and draw the same conclusions; in a way, it becomes a self-fulfilling prophecy. There’s nothing magical about it. It just underscores the power of technical analysis (like chart-reading) over fundamental analysis and explains why academics and Wall Street professionals hate chart readers.

Perhaps making money in the market is less about studying companies and their financials, understanding macro- and international economics and exchange rates. Perhaps it’s more about understanding market psychology and herd behaviour. If enough people come to the conclusion that when the index drops to the 1150-1175 range it will be time to take a breath, to get your bearings, to sort things out, the the Index will begin to consolidate (if you think you’ve heard a lot of talk about “bottoms”, wait till the Index drops another 5%).

But we’re ready and won’t fall into the trap of thinking that good times will then be around the corner. We’re going to wait until the MTI signals an all-clear. The rest of the summer could get painful (remember, water-torture). Another month or so after that (perhaps around the time of the election) we’ll have a clearer idea of the over-all direction as we enter the 2nd year of this bear market.

In the meanwhile, we’re not even going to try to find stocks to buy …. the odds are so poor for making money by “going long”. We’re just going to sit it out on the side lines following the strategy described yesterday.

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