the market must by definition always be wrong because its
participants are emotional, rather than logical, creatures. A natural
conclusion emerges: The market can never rest at its objective,
logical level. As emotional beings, we are perhaps incapable
of determining such an objective, logical level anyway, even if we
delude ourselves to the contrary.
When the market does rest, it is at an emotionally comfortable
level and is therefore inherently unstable. I would argue that
only a person with a highly trained mind who has spent many
years studying meditation techniques could maintain a reasonable
mood consistently for any period of time. A market made
up of thousands of participants has no chance.
Price action is, to use a cliche, the bottom line. It does not matter
one iota if you manage to get the economics right while the
market goes in the opposite direction. This difference between
what the market “should” do and what it does do is seen all the time. Why? Simply
because of the age-old laws of supply and demand—the actual gross buying versus
the actual gross selling in the market as opposed to theories on the potential
movement in the broad economy. (I have used the term gross because in this age
of huge individual-entity market participants, it is sometimes the case that, although there are more
buyers than sellers, the market goes down because the sellers’ positions were bigger.)
The economics of a country are but one influence on a
market—regardless of whether we are looking at equities, bonds,
or currency markets. Other factors that come into play are the
market’s performance relative to other economies and markets
and even the global political environment. Where all these
factors lead, however, is to one elegant place: the mind of the
market participant. The final computation of all these factors
is then filtered through the enigma of that human condition, emotion.
The way market participants use emotion to filter information
varies from day to day, depending on all sorts of factors—from
the weather to whatever market position is already in place.
Participants who are long a market will largely filter out any
bearish news developments. Against this, participants who are
short a market will focus almost completely on bearish news. Yet
all information is absorbed. The net combined effect of all the
fundamental forces and all the emotional filters is the collective
view of a market—that is, its current price. Is it any wonder that
prices are almost always unstable? This innate instability of markets
is, in effect, the “emotion” of the marketplace.
Perhaps a slightly more contentious point that I would also
offer for consideration is the differing emotional structures preexisting
in different markets. As traders, we are increasingly
trading globally. A phenomenon I have observed among market
participants is actually nationality based and even relates to
some sectors of the markets’ political beliefs as well. It is not
uncommon, for instance, for traders in the United Kingdom to
be slightly more negative in their attitude toward their own
economy and the release of data on their economy than perhaps
U.S. traders would be about similar data outcomes regarding
the U.S. economy. There seems to be a natural pessimism about
U.K. trading behavior, compared to a slight state of enthusiasm
in U.S. trading. It has been observed that, generally speaking,
different cultures have varying psychological profiles. In these
two examples, neither is realistic, but both present opportunity.
If we understand that U.K. trading will tend to overreact to negative
data and perhaps slightly depreciate positive data, then we
can look to take advantage of the temporary price overshoots
thereby created. This principle works similarly, and in reverse,
in the U.S. markets.
Financial markets are very much a product of laissez-faire
economic thought. It is only natural that any sample of market
traders would then tend to discover that on the political spectrum
the bell curve is skewed slightly to the right. This explains, in
addition to the more obvious point, why markets tend to dislike
left-leaning governments around the world and embrace governments
that are more conservative. Again, this creates opportunity.
As a warrior trader, you must always be independent in
thought when approaching the market. Observing a market
overreact to good news in a conservative government economic
environment relative to the treatment of good economic data in
a less than conservative environment can be a factor in increasing
short- to medium-term trading success. It is all emotional,
even on levels people are not always aware of.
How can you monitor and keep up with this combined unstable
emotional force? You cannot gauge a market precisely; however,
you can get an effective handle on its current direction and
whether it is bullish or bearish. The tool for achieving some
awareness of the overall emotion of a market is technical analysis.
The other reasonably effective method I am aware of for
achieving this is to simply watch trading screens for a few hours
after a piece of economic data has been released. This allows you
to see whether the market has moved in the direction suggested
by the data or not, and to what degree. (I suggest a few hours
because immediate volatility after an economic release can be
like fool’s gold, and it is a lure that can entice many.) A shortterm
trading strategy can be centered around the price at which
the market sat just prior to the data release. If the market moves
in response to the data, and the price movement is valid, then it
should not retrace beyond that immediately prior to the release
price level. If it does, then there is probably an even bigger trading
opportunity in the direction opposite that which the data
release indicated.
Read More: THE MARKET IS ALWAYS WRONG
