Profiting from Behavioral Economics:
Betting against the masses has been a proven method of generating steady returns since the rise of modern markets. Humans are emotional beings, wired and conditioned to think and act a certain way. For instance, those of you who have enjoyed the game of golf have likely sliced countless golf balls and watched them curl off into the woods. The human body is built to throw your golf club at the ball like an axe, not to produce the unnaturally eloquent form of the perfect swing. Unless you're genetically gifted or have taken lessons (more likely), this bad habit is probably still with you. The same principle applies in investing. It is in our nature to have extreme difficulty buying when the world is screaming 'fire' to experience the same difficulty selling when markets reach new highs and every person you meet at the local coffee shop is talking about getting in. To become a consistently good investor, you must be a contrarian. This takes time, training, experience, and the use of a few effective tools which we will cover today. Trading by use of market sentiment is commonly referred to as crowd psychology. It is measured by several things:
1. The breadth of the market, follow the money.
Advance/decline ratios are calculated daily and analyzed. They are a measure of which stocks are making higher highs or lower lows on a daily basis.
The bear/bull ratio is also a useful measure of breadth. It measures investment advisors current feelings on the market.
The ratio of put/call option bets: a forward looking measure of money-flow impact on futures price.
The Volatility Index can monitor any security if you have the expertise. It monitors bets on fear and anxiety into the future. Its symbol is VIX.
One resource for the average investor to track many of the things we have discussed and become a successful contrarian trader is the site Sentiment Trader (we are not being compensated for promotion).
Gold is setting up for the second largest drop of the year before the month of July ends. It will most likely stay elevated until the Federal Reserve meeting at the end of the month. The upper chart is price vs the lower chart which is sentiment. One can easily see the correlations over time.
With the Fed pumping trillions into the system, sentiment in the stock market can stay overbought for a longer period of time, but eventually corrections come home to roost with sharp, mini-crash events. This is the current pattern of markets we trade in. Many natural corrections are aborted by the artificial capital inflows into the markets which make the corrections when they do occur faster, harder, and scarier. When they finally occur it's comparable to a dam breaking.
Several contrarian trade set-ups worth a look are the following industries:
One of the best contrarian bets we see out there currently is Tyson Foods, one of the world’s largest producers of chicken. The world loves chicken as a good source of low-fat, lean protein. Tyson is here to stay and severely undervalued.
We expect Tyson to regain the lower yellow channel in the short term and trend higher into the Fall.
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