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Fear Behind The Wheel


Nothing drives like fear. Greed may be good, but fear is great. Fear is Mr. Market's Ferrari.


"Said my get up and go musta got up and went
Well I got good news, she's a real good liar
'Cause the backstage boogie set your pants on fire."
Sweet Emotion (Aerosmith)

First and foremost, the understanding that the market is essentially a psychological animal is critical.

The old saw is that the market swings from greed to fear on all time frames. But, if you stop to think about it, it is actually fear that moves the market. Nothing drives like fear. Greed may be good, but fear is great. Fear is Mr. Market's Ferrari.

Fear is the driver: greed is simply fear of not having enough.

It is a fear-based pursuit, because if you've been in the game long enough you realize that there is no way to beat the market at its own game. As traders, we are underlings. But with that realization comes the humility to follow the market rather than insist the market mold to our view.

The Achilles' heel of quant is now obvious to everyone. It is clear now that even the machines can't be right all the time, that the black boxes can't be right enough to ensure consistent gains. In a nutshell that the math of the machines is subject to oversized drawdowns. It is clear the machines can't be right all the time: they don't model human behavior. They know nothing about time.

And when the machines are wrong, they really stink up the joint.

The frailty of the algorithms has thrown the Street for a loop. When program trading accounts for well in excess of 50% of daily volume, when there are thousands of hedge funds not just following but creating and perpetuating their own momentum, is it any wonder that emotion has erupted when it is revealed that the emperors have no clothes? Is it any wonder that pure emotion has erupted triggering violent swings not seen in a decade?

Click here to enlarge.
1458 – 1459 (A) is key support. Markets often trace out 3-Swings-to-a-Test of resistance, but sometimes you get a fourth.

No mechanical system can put the pieces together of something ruled by human emotion as well as the human mind. Despite changes in fundamentals, generations play out the same extremes of emotions.

The realization that risk is risk and that ultimately risk can't be shifted perpetually has seized the Street, accelerating emotions.

Risk is risk and eventually ends up at someone's doorstep: chickens eventually come home to roost. Currently, the market resembles a chicken running around without its head----swinging wildly as it attempts to know what it doesn't know. If you can keep your head about you when all others are losing theirs, then perhaps you didn't understand the issues.

And if you think emotion has seized the tape, next week sets up as something to behold. For another perspective, next week a lunar eclipse looms on Tuesday, which coincides with the last week of August, a period that is historically is fraught with significant turning points. August 25, which falls on the weekend, is a mirror image of the February 22 peak and the 1987 all-time high. Will it be a high or a low?

It the current rally phase persists into Friday, it may be a superior opportunity for selling and selling short. It will be interesting, to say the least, to observe players' willingness to hold positions over the weekend.

It is going to be interesting to observe the ability for the S&P to hold this morning's emotional gap up over 50% of the July/August range.

Click here to enlarge.

On Wednesday the S&P closed above a necktie of its 200 and 20 dma's and closed at 50% of the July/August range (A – B) and against a downtrend line (C).

Despite Treasury Secretary Paulson's assertion this week that economic fundamentals are strong and that the market follows the economy, it is actually the market that leads the fundamentals.

If the market is a discounting mechanism, you can't look back at where we have been in the economy and say that is where the market is headed.

So, the question is the nature of the emotional rescue attempted by the head of the U.S. psychology department. Can the market's manic-depressive flare up be quelled this quickly?

Are we in the eye of the hurricane? Is this the calm before the storm? A study of panics shows that they persist for a minimum of 55 days to 90 days.

It will be interesting to observe the lunatics as the lunar eclipse hits.

Editor's Note: Want more of Jeff's insight and trading ideas delivered to your inbox daily? Minyanville has now launched Jeff Cooper's Daily Market Report, complete with Jeff's day trading and swing trading setups. If you're interested, please email Josh Sander to join so you don't miss one report.

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No positions in stocks mentioned.

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