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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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For example, an investor watching this chart would have noticedBear Market Legs Trouble is only opportunity in work clothes.Henry J. Kaiser Its a bit easier to define legs (or phases) of bear markets than of bull markets because they are more compressed in time, more sharp in movement, more dramatic. Yet, despite this, most people react to each secondary reaction as though it were the end of the bear market. My discussion of secondaries in the last chapter leaves one other aspect yet to be touched on in this area. I refer to bear market legs. This is perhaps the most inexact aspect I have thus far discussed, so I shall not dwell long on it. A leg is a phase of the market that can last anywhere from a few days to a few months, depending on how far you break it down. A bear market can usually be broken into three legs or phases, and each of these in turn can be broken into three smaller legs, and each of those in turn into three. The major legs are rationalized as follows: the first major leg occurs when the euphoric expectations of unrealistically high stock prices are abandoned. The second leg occurs when more stocks are sold based on decreased economic conditions, decreased earnings, a rise in unemployment, etc. The third and final leg occurs when people cash out their stocks because their income has decreased so much that they simply need the money. Bear Market Legs53RECOGNIZING BEAR MARKET LEGSEach leg in a bear market ends, almost without exception, on less volume thanthe volume occurring on the panic-declines or crashes.For example, the crash in1929came on high volume very early inNovember, and the low of that bear leg came on considerably less volume inmid-November. In 1937, the crash came on big volume in mid-October, but the low of the leg came on much less volume at the end of November. In 1946, a pair of crashes, both on large volume, came in early May, and the legs low came in early June on notably less activity. In 1962, the market crashed on massive volume in the last week of May. But the low of the leg came at the end of June on much less volume. In 1966, a similar pattern to 1962 was observed. With the coming of the 1969 bear market, the pattern changed somewhat, probably because since 1969 the stock market has been more and more affected by political actions in addition to pure economic considerations. In all bear markets since, the decrease in volume, while noticeable, was far less pronounced than it had been in prior bear markets. In fact, the best way one was sure that the last bear leg had been seen was the sudden rise in volume while prices also rose. Another reason for this distortion is that more and more money moving into the stock market is pension funds and thousands of new mutual funds. This means, when this money moves, it shows. The funds and institutions may not be right in their assessment of market conditions, but, at least temporarily, the sheer movement of such large amounts of money into any investment vehicle will cause that vehicle to rise. The vehicle having risen, traders, who jump on anything moving, will get aboard as well. This carries the move forward. In the last 5 years or so, as CNBC and other financial programs increasingly needed excitement to keep people watching, the tendency to overdramatize all news, both good and bad, goaded traders to buy or short those markets on a daily basis. In the last 2 years, it has been fascinating to watch how many times the pre-market futures prices and direction was the opposite to how the market eventually finished the day, as traders made bets against the trend which they were pretty certain would occur once the market opened and normal folks bought and sold. We saw this particularly in the 2 weeks following the reopening of Wall Street after the September 11 attack, when the Dow and the Nasdaq dropped like stones. Yet, markets quickly returned to levels that existed before the attack, once traders covered their shorts and went back to the serious business of making markets. A concept sometimes heard is that, of three legs, the first is down (in a bear market), the second up, the third down. But a more widely accepted version is that the three legs are all down in a bear market or up in a bull. Statistically, it has been pretty well proven that major bear markets all have a minimum of two legs and potentially from three to eight. The crash of 1929 had, so far, the greatest number of legs of all bear markets in history: eight. A repeat performance is not out of the question, but in my opinion, extremely unlikelyin any future major bear market. Legs are simply a way of keeping track of the market on a broader perspective scale. Thus, when a market moves in a new direction and then seems to grind to a halt, amid talk that its all over, you can shake your head and figure there is bound to be at least another leg in the same direction shortly. The perspective of market legs gives your thinking balance, just as your bodys legs give your body balance. TECHNICAL RATIONALE BEHIND LEGS The technical rationale for legs is that the market moves in waves or series. When enough momentum has accumulated to push the market, lets say down radically, there surely must be enough pressure to cause it to follow through, to continue to press on despite setbacks, in a series of waves. It would be quite illogical to see a market drop sharply from high ground and then recover and zoom on immediately to new highs again. Like a runner whose pace has been broken by a fall, he has to get in stride all over again, and this takes timefor momentum, speed, and direction. Tidal waves usually have follow-up waves in the same mannersometimes smaller, sometimes bigger than the first. The Elliott Wave Theory, which attempts to predict the market almost entirely on this wave principle, maintains that, in the stock market, these waves come in a series of five, and, until five have been completed, it is unlikely for a major change of trend. But regardless of number, the principle of multiple waves or phases or legs is more or less scientific. LEGS ILLUSTRATED Figure 7.1 illustrates legs or waves or steps. We see three clearly defined legs. From A to B is the first leg, from B to C the recovery. From C to D the second leg, from D to E the recovery. From E to F the third leg. (If you prefer to think in broader movements, you can eliminate the second leg and call the move from C to F a single leg, which is technically more correct.) We then note the recovery movement. From F to G, the first leg up; with G to H the reaction. From H to I, the second leg up; with I to J the reaction. From J to K (as far as this figure takes us) is an unfinished third leg. By studying legs, one gets a better idea of where you are and what may lie ahead. For example, an investor watching this chart would have noticed that when peak C was past, it was very likely that another leg down was due. Then, when the market dropped below the level of point B, a down leg was a virtual certainty. Selling out at that time, though well below the top, was still well above the lows. And short positions at that moment would have paid off handsomely. NOTHING IS CERTAIN Because nothing is certain in the market, you must always assume its possible for a reversal to take place. Thereafter, even after only a single bear leg down, you should start watching (a la 1987). After two bear legs, you should be much more alert, and after three legs, you can begin to anticipate a reversal with growing conviction. Of course, the same principle holds true in reverse in bull markets. But, somehow, people in the market find it hard to turn their thinking upside down to apply normal rules in reverse during bear markets. WATCH RELATIVE LEVELS Remember to watch for a rally high closing above a prior rally high, then dipping, but holding below the former low. When you see this in a bear market, its time to assume the new trend is up. This premise works in determining when a bear market is starting. Thus, when prices fall lower than the last decline and then rise but fail to reach the last rally high, you must take the position that a downtrend is under way. And all trends must then be assumed to remain in effect until reversed again. This can be a matter of days, weeks, months, or even years. |
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