Bad Habits

Based on a simple trend following method I recently outlined for Trader Planet readers using the monthly chart of the S&P 500 (with a trend line and a 13-ema), U.S. equities have entered a confirmed bear market. The problem isn’t just that. Most bourses worldwide are already down more than 20% from their peaks. Not just mendacious China, but Germany, France, Japan, the U.K., plus the Russell 2000, the bank index, the transports, etc.

Bear markets offer plenty of volatility, but most traders have difficulty taking advantage of it. I think the reason is that Bull markets often condition traders to think and behave in ways that are sub-optimal. Like a too permissive parent, they tend to reinforce bad habits. Typical examples include buying high, following tips from the media, chasing momentum, trading without stops and over-trading, just to name a few.

During Bull conditions one can often get away with these behaviors, because Bull runs are essentially forgiving of common trader mistakes. If you fail to take a stop, the stock will probably bounce back. If you bargain with the market gods, praying to get out at breakeven, your prayers will probably be answered if you are patient enough.

The real problem is that the more one is rewarded for sub-optimal behavior the more it becomes a viable option in a pickle. When we win sloppy, we often misinterpret our good fortune as skill. This is the main point of Nassim Taleb’s book Fooled by Randomness.

While Bull markets are not necessarily ‘easy’ to trade, because pullbacks tend to be sudden and sharp, they are nevertheless quite a bit easier than Bears. Bear markets tend to punish the default habits that worked so well during bull phases, which is why Bear markets decline on a slippery slope of hope.

The sentiment poll at AAII (taken a week ago, there will be an update today) shows 34% bears and 27% bulls, which indicates to me that there is still plenty of hope in the air. Nice Bear market bounces happen when the bearish reading is above 60. We have a long way to go. (Coaching for private traders.) (Peak performance consulting to RIAs, hedge funds and banks.)





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