After living through two bear markets, most experienced investors no longer believe that an economic theory positing a random walk by rational agents accurately models the behavior of modern financial markets.

 

The relatively new field of behavioral finance was founded by Nobel laureate Daniel Kahneman, who delights in pointing out the myriad irrational processes that typically occur when individuals are forced to make financial decisions under uncertainty and risk

 

It was the installed base of traditional market models in 2001 and still in 2007 that grossly under-estimated the risk of the dot com bubble and the housing bubble, respectively. About a decade apart, both Alan Greenspan and Ben Bernanke committed this tragic miscalculation.

 

They underestimated risk because they disregarded the influence of human factors, including emotion and feedback loops, in market dynamics. In the real world, price will often move much further and much faster than traditional rational-actor models suggest. Benoit Mandelbrot has shown that the discrepancy is many standard deviations, drastically increasing the real-world odds of catastrophic events. The black swan is always swimming just out of sight on the other side of the pond.

 

To bring this discussion into practical focus, many high profile Nasdaq leaders such as Netflix and Apple have very unstable long-term volume profile configurations. This makes them vulnerable to feedback cascades that eventually  lead to massive liquidation events.

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One of the most vulnerable leaders, however, is not an individual company’s stock, but rather a sector: biotech. The all-too-human emotions of greed and fear are likely to wreak havoc on this sector over the next 12-18 months leading to a peak to trough decline of ~76%.

 

Of course, when the general public liquidates an anointed sector, value investors sacrifice a goat to the market gods and gladly take the other side of the trade. It takes guts and discipline to do this. To increase your trader courage and discipline the easy way visit: http://www.daytradingpsychology.com/increasing-trader-discipline/