Fear And Greed – A Traders’ Best Friend?

July 31st, 2010 |

Author: man

What do you think is a stronger emotion, greed or fear? Let’s take a look at that by looking at a few examples…

Let’s think back to a stock broker who was doing his job in during the stock market boom around 2000. His job was probably pretty straight forward, right? From his point of view, everyone wanted in on the profits. Typically, when the uneducated public learns of a quick way to make money, they’re usually speedy to hop on the band-wagon to squeeze out a quick dollar. However, the stock broker still has to make an effort (sometimes with outgoing calls) to get people to trust his brokerage.

Greed may be a heavy emotion, but I think the fear of loss is much stronger. Here’s why…

Now think about that same rookie trader, who was uneducated in market dynamics, when the bubble started to explode. As prices were falling quicker than a lead filled balloon, who do you guess was being “proactive” then? My bet is the stock broker didn’t have to do any outgoing phone conversations. As a matter of fact, I’m willing to bet his phone was ringing off the hook with traders begging to pull their money out of the market.

I think the time fram from February 2010 up to May 2010 gives a premium example in the differences in greed & fear. You’ll see how it took almost 3 months for the market to gain about 180 points, but it only took 1 week (only 9% of the time) to lose about 90% of the previous few month’s profits.

In Chris Dunn’s blog post on 05/05/10, he explains how the DOW had a major sell off of close to 1,000 points in around 1 hour. He gives an example when the rookie traders go mostly long biased the market right around the same time frame the pro’s go net short the market. If you take note at the COT Net Position technical indicator over the past few years, you’ll see a pretty steady opposite correlation compared to the pro investors and retail investors. It’s pretty much like the wealth gets moved from the retail traders to the pro’s.

As professionals, one of the most important things we can focus on is what the other non-educated retail are believing… and do the opposite. If we can spot the actions and point of views of the public ahead of time, we can almost always win big.

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