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Behavioral Trading and The Appetite for Risk


What are we hungry for? Risk or, no risk?


"Feeling Up" is Not What it Used to Be?

Sentiment is only one symptom of the market. It is a critical input but is not always overt. We would all like to see markets top and bottom on the same levels of sentiment. But, sentiment levels, like stochastics or P/E ratios, are only data after all. They always have to be interpreted. More importantly, or put another way, Quanta may be less important than Qualia. Each market process moves through a set of psychological phases. Thus, although current sentiment levels are now nearly the same as they were at the May highs, the market is different. Now, investors are experiencing a "Failure" from range highs. While a tactical decline is overtly unfolding, this emotional pattern may also be part of a longer term topping process. In fact, the "Recognition" that structural stock upside is limited may now begin to alter strategic expectations. Stocks have been "feeling up" lately but the market doesn't seem as satisfying. Or perhaps investors are cognitively satiated on the good news component inhabiting one side of their Neocortex? Now let's see how bonds are feeling.

Bonds Take Stocks Back to School?

Bonds had also been "feeling up" into late Summer. The recent reversal in the stock market has been, in part, rationalized as a reaction to the backup in Treasuries. Given the preferred pattern for a tactical short-covering bear top in Treasuries and the overt, albeit widely advertised, negative seasonals & cyclicals, early September is the perfect time for the bond market to be taking the stock market to task. Bond market sentiment, as shown below, has rallied back to levels of the prior bear market extremes since the duration/deflation seduction extreme of June 2003. Many pundits are celebrating the end of tightening. But, is inflation whooped? Is copper crashing? Maybe it was only a "Beltless Tightening?" The Treasury market is at risk of at least a backup and provides a "convenient truth" for stocks to enjoy at least a tactical spill.

All Together Now

Stocks, bonds, cash and commodities are all different assets which we think and are taught should be alternative portfolio choices. But why have they been going together? They rally together, they fall together, they hang out together…it's financially incestuous! It should not be happening. It isn't the asset for asset lovers and haters. It is us. What are we hungry for? Risk or, no risk?

So, What is the Appetite for Risk?

If you could answer this question you would hold the key to behavioral finance and to psychology itself. We don't know even though we want to know and usually pretend to know. Some people have called it "Mr. Market." Keynes called it the "Animal Spirits." But he only borrowed it from the Greeks and the Greeks got it from Vedic pundits who called it….? (This is an ancient Trivia question…emailing me the correct answer will warrant a free Behavioral Trading report.) We humans can send a man to the moon, but we are far from understanding our own psyche. In reality, all we can do is observe the ever changing phenomenon of risk appetite. We may not understand it but we could profitably follow it from time to time. Some thoughts from a Minyan who is always in the Mountains: "Don't follow the money, follow the risk appetite and as always, Minyan on."
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No positions in stocks mentioned.

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