The bell rings and the market buys.  Pavlov would be proud. 

Watching the market over the past few months has indeed been an interesting venture.  For those of us who spend our days in front of our monitors watching every tick, a new phenomenon seems to have emerged.  What used to scare the Street into the corner has now made it bolder. 

What I’m referring to is the market’s ability to step right up and buy after triple-digit down days.  The Dow Jones Industrial Average (INDU) falling by triple digits now acts as a buying stimulus for investors, or “the bell.” 

The bell rings and investors buy.  Pavlov would be proud.

Looking at the tape, the Nasdaq Composite (COMP) has teetered between winning and losing sessions for the last nine days. 

The bell rings and investors still buy.

Over the past two months, the INDU has seen 13 trading sessions of plus or minus 100 points.  The sum total of these triple-digit moves is approximately 2,200 points.  But INDU has netted only +275 points over the same time period.  Talk about volatility. 

Despite the volatility, the bell rings and investors still buy.

Subprime concerns rear their ugly head and cause the INDU to drop 226 points. 

The bell rings and investors still buy.  You get the idea.

So is this a bad thing?  You’d think so, if only because I’m writing about it.  Just like city hall, you can’t fight a market trend.  Once the market gets its mind set on a direction, it becomes harder for rational arguments to carry any weight against that direction.  This proves a few things.  First, the trend is truly your friend (one of the oldest proverbs on the Street).  Second, following the crowd does pay … sometimes … but it’s never good to be a lemming.

One thing the current environment tells us is that investors have been willing to look beyond the day-to-day in favor of the market’s intoxicating long-term trend.  We’re working on the second-longest bull run in history (without a 10-percent correction), but to hear some investors talk, you’d think we’re in the first stages of the rally.  With that in mind, I’d like to introduce you to the stages of a market rally, according to our Behavioral Valuation approach. 

————— INTERNAL ENDORSEMENT ————–

Imagine if There Were Only 6 Numbers to
Choose from When Buying a Lottery Ticket!

Wouldn’t that be great?! Of course, the less the number of choices, the more likely your chance of success, right? How many choices are there when buying and selling shares? Errmm… a LOT!

Hundreds…One of the reasons I enjoy such consistent success from trading, is because I only have 6 options to choose from! Except this is even better in a way, because the lottery is pure luck…

I only have 6 choices AND have a VERY good idea about which choice to make because of the insider signal.

—————————————————–

There are four stages to any rally, whether it’s in a stock, sector, or the market.  A rally starts with the first stage - Despair.  That’s right, something as gloomy as despair kicks off a rally.  We’ve all heard the term “the market climbs a wall of worry.”  Well, the wall is tallest when there appears to be no light at the end of the tunnel.  When investors have thrown in the towel.  When you can almost hear a collective groan when investors look at a chart.  This is “Stage One Despair.” 

Why does this mark the point at which a rally will kick in?  Well, if investors hate stocks, it’s likely that they’ve sold them.  We’ve all heard the term “oversold,” or a point where a stock is technically due for a bounce.  The same theory applies to investor behavior. 

When despair has reached a climactic level, it signals that investors have likely exhausted all of their potential selling pressure.  This means that the risk/reward balance has shifted away from risk, as there are fewer participants left to apply selling pressure.  Put simply, just as you can get the best seats in a theater when it’s empty, you can find the best deals on stocks when investors have left the market due to their despair.

We gauge whether despair has set in by monitoring sentiment indicators such as investor polls, options activity, analyst recommendations, short interest, media buzz, and other signs of how bearish investors are.

Back to this week’s market and ringing bells.  Given the Pavlovian-like response of investors to buy the market when the bell “rings,” one can easily deduce that the market is far from the Despair stage.  We’ll discuss the other three stages of a rally - Disbelief, Acceptance, and Euphoria - and each stage’s signature and market implications in the coming weeks.

Have a great trading week.

CJ

P.S.  To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com.

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