Last August I was talking to a hedge fund manager who told me that his models suggested that the market would finish strong in 2012 and continue to go up in 2013. But what he said right after that is very revealing; he was afraid he might not be able to profit from it.

 

 

A lot of traders have been thinking: “I don’t want to be the last buyer.” Or,  “I can’t buy the pullback, it might be the beginning of the real sell-off”.

The anxiety of watching the market move up in a strong trend while being left behind is only compounded by listening to market pundits who insist on calling tops.  Even in a strong trend, why do some people insist on calling tops? Several reasons, and here’s three of them.

First, the strength of this market has caught many by surprise.  The market seems to have climbed the proverbial wall of worry.

Second, how much of the move is a byproduct of priming the pump? Everyone has his or her own answer to that.

Third, market pundits will generally be more wrong than right around new market highs. If you ever get the chance to personally talk with one of them ‘off the record’ you might hear them say they know they get a big pat on the back if their market top call is right. They may even confide in you that it’s ‘too easy’ to be bullish’; they don’t get a big pat on the back by saying the market will continue up and it does just that.

There are many more reasons, but let me offer you a unique view of how a market psychologist views new market highs.  

I have a trader friend who used to be a professional poker player at the tables before online poker was big. I asked him why some poker pros consistently make more money than other pros if everyone at the pro level has a similar skill level and the same probabilities memorized. He said that the edge in poker appears to be the numbers or probabilities, but the real edge that sets one pro apart from another is the ability to read the table, to bluff and to read other bluffs. The best players, he said, were playing other people as much as they were playing their cards and their probabilities.

As a trader I find it helpful to think of the market being made up of three teams. If I’m long, the first team represents all the other longs.  The second team represents all the sellers (shorts and profit taking longs) and the third team represents traders on the sidelines, nether long or short. . My long will only continue to work if enough firepower from the third team gets off the bench and joins my side. If they join the other side, my trade is done.


The question to ask around new market highs is not whether the market has gone too far too fast. We know that markets can stay overbought (or oversold) for a long time. The question we should ask is, what, if anything, will continue to motivate players currently on the sidelines to join the long team?

If the market continues to stay strong, the fear of missing out and short covering can easily push the market further up, and that can attract momentum traders.  And the cycle begins again.

The hedge fund manager I spoke to last August reached out to me a few weeks ago and said that he couldn’t stand missing the move any longer, fearing potential fund redemptions if he significantly underperformed the S&P. He said, “I really don’t feel comfortable buying here, I don’t want to be the last buyer, but I feel like I have no choice”.

Something to remember, every up trending market needs bears, otherwise there wouldn’t be anyone left to buy!