Bull traps lead to bear market losses
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The rise in the stock market looks reassuring and exciting. In just two weeks, the company recovered more than half of the ground lost in the three-month selloff. However, this observation comes with a warning that another, deeper sell-off could soon occur.
First, look at the stock market picture. The August-October selloff had many negative signs. (See my previous posts for explanations.) Then the last two weeks came with indicators that are likely false positives, as explained below.
2023John Tobey (StockCharts.com)
The problem is that starting a new bull market takes time. Investor attitudes must be improved by “overcoming the wall of worry”. It’s the false reversals that occur when a selloff pauses. Such reversals, if dramatic enough, can develop into “bull traps.” These loss-making actions result from enthusiastic, optimistic purchases that go awry when sell-offs suddenly return.
Why “trap”? Because when the rise undergoes the first downward reversal, it is seen as a new buying opportunity. If the rise does not continue again, the realization comes that the old sell-off has returned. This leaves investors with the troubling decision of either selling at a loss now or holding on and risking even more losses later.
Note that once again human nature is behind the wrong views and actions. The following descriptions explain the bull trap and the role of human nature well…
From an article in Finance Strategists (September 7, 2023): “Bull Traps”
“What is a bull trap?
“A bull trap is a false market signal that indicates a reversal from a downtrend to an uptrend in the price of a financial asset. This deceptive signal leads investors to buy and expect the market to rise.”
“However, the asset’s price falls shortly thereafter, falling into the trap of optimistic traders who bought in anticipation of growth that never materialized.”
…
“Given today’s fast-moving, interconnected financial markets, the prevalence and impact of bull traps have increased due to rapid swings in investor sentiment.”
“Role of market psychology in creating bull traps
“Market psychology plays a central role in the creation of bull traps. Investors driven by fear of missing out (FOMO) may jump on the perceived uptrend without adequately assessing market conditions.
“This buying spree may accelerate price appreciation and further fuel the perception of a bull market. But if this optimism is not supported by fundamentals, the correction can be swift and severe, resulting in a bull trap.”
Conclusion: Stock investors were not pessimistic before the rise
While some articles suggested this notion and worse (panic!), polls showed little concern. In fact, on October 24th, just before the bullish reversal, the very good weekly US Advisors’ Sentiment Report showed a healthy reading of 50% upside and 24% downside. It was similar on November 7th. Most likely the reading on November 14th will be even better.
Furthermore, the stock market’s rapid two-week rise confirms this low level of worry. If investors were truly concerned, they (and the media, which tends to reflect investor sentiments) would still be struggling with the negatives. Furthermore, the market would fluctuate and work its way through a reversal (but only if the fundamentals supported such a move).
Therefore, do not consider this recent increase as an indicator of a better future. When a bull market truly begins, there is a crooked road ahead. All the negative aspects that remain with us must be eliminated before we can return to a runaway, out-of-control, fad-driven bull market.
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During my 30-year career, I have managed and advised multibillion-dollar funds. Using the “multi-manager” approach, I have worked with leading investment managers. I now manage personal accounts and write about my analyzes and decisions.
My 50+ years of personal/professional investing experience have developed the skills I use to identify opportunities and avoid risks. Because markets are constantly changing, I choose the strategies (security, income, value and growth) that the conditions require.
My only regular activity is to look for developments and trends that are ignored or misinterpreted by investors. These are situations that consistently result in higher return opportunities (or higher levels of risk).
I am a CFA charter holder with an MBA from Stanford Graduate School of Business and a BS in Finance from San Diego State University. I am a former CFA board member in Washington DC and served on the AAUW Investment Advisers Committee for eight years. I am in my ninth year on the City of Vista’s Investment Advisory Committee.
For more information, see my LinkedIn bio at http://www.linkedin.com/in/johntobeycfa
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