How the flu pandemic impacts your trading
I was recently looking at weekly breadth statistics for the NYSE and noticed
that, over the past four weeks, the cumulative number of declining stocks has
exceeded advancers by over 3000 issues. This has only occurred on six
prior occasions since the bull market began in 2003. Interestingly, the
number of cumulative advancers vs. decliners during the next four weeks was
positive three times, neutral once, and negative twice. No real edge
there. Indeed, if we look at the ten occasions in which the cumulative
number of weekly decliners has exceeded advancers by 2000 or more over a
four-week period, we find that the average cumulative balance of
advancers/decliners over the next four weeks is only 59, compared to 1961 for
the sample overall (N = 132 periods). While declining periods in the
markets typically end with large breadth gaps favoring declining stocks over
advancers, the reverse is not necessarily true. Large pluralities of
decliners over advancers do not uniformly lead to bullish reversals. This
is because those negative breadth readings tend to cluster. Eight of the
ten high negative breadth periods analyzed above, for example, occurred during
two blocks of time during the April/May period of 2004 and 2005.
Psychologically, fear begets fear. This is why bear markets tend to be
shorter in duration than bull markets. Once fear hits the marketplace, it
feeds upon itself until sober groups of value participants decide to scoop up
the bargains. That is how panic
can produce fantastic buying opportunities, even as fear can multiply upon
itself. For years I have tracked a basket of stocks that mimic the
S&P 500 Index and studied the new highs and new lows made by this group on a
rolling ten-hour basis. (This indicator is tracked daily on my blog). Longer-term rises and declines–those
lasting weeks to months–rarely terminate with a maximum number of new highs or new
lows. Instead, what happens is that we hit a momentum peak or valley in
new highs or lows, then see value-oriented selling or buying, and then proceed
to make subsequent peaks or valleys with a diminished level of new highs or
lows. Only then do reversals ensue. Technicians call these
divergences, but they actually are manifestations of waning emotional
extremes. Bullishness must wane before there is a sustained decline and
vice versa. In my field of psychology, we see the same thing.
Clients do not go from being depressed to being euphoric (unless they have a
bipolar mood disorder). Rather, they go from being depressed to being less
depressed, to feeling neutral. An anxious person needs to feel less
anxious before feeling truly calm. Emotions, in people and markets, rarely
turn on a dime.
For quite a few months, I have been tracking the avian flu situation and
monitoring headlines across the world. Until recently, the headline
stories were confined to the Asian media. Now, in the wake of hurricane
consciousness, there is general alarm about preparedness. As we see the
government take action regarding avian flu, headlines are now front page in the
American media. I cannot accurately gauge whether or not there will be an
avian flu pandemic and whether such an event would prove relatively mild (as in
the past two pandemics) or severe (as in the Spanish flu episode now receiving
press). What I can tell you is that the number of avian flu headlines has
skyrocketed and my monitoring of online pharmaceutical sites suggests that there
is a major run on Tamiflu stock among private citizens, given increased
governmental stockpiling.
Fear begets fear. Long before we could possibly know whether outbreaks
of transmissible H5N1 virus pose a serious pandemic threat or not, people–and
markets–will likely react. Indeed, in the wake of accusations of
hurricane ineptitude, governmental authorities and helping agencies might even
overreact. As a psychologist and trader, my job is to observe panic–not
participate in it. I keep my pulse on the emotions of the marketplace and
prepare myself for the days, like last week, when I might have to rein in my
desire to pick bottoms.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of
The
Psychology of Trading (Wiley, 2003).
As
Director of Trader Development for Kingstree Trading, LLC in Chicago, he has
mentored numerous professional traders and coordinated a training program for
traders. An active trader of the stock indexes, Brett utilizes
statistically-based pattern recognition for intraday trading. Brett does not
offer commercial services to traders, but maintains an archive of articles and a
trading blog at www.brettsteenbarger.com.