BULL MARKET TOPS

Friday, November 13, 2009

In the stock markets, the surest way of making the biggest gains is to buy when a bear market touches rock bottom, and to sell when a bull market scales a major peak. The only snag in this strategy is the fact that its successful application depends upon the timely identification of bear market bottoms and bull market tops. This is easier said than done because such tops and bottoms are always easier to spot through hindsight (often described as an exact science)than ahead of time. Time and again, it has been observed that the advance identification of such tops and bottoms often eludes even the most knowledgeable and seasoned of investors. However, this does not mean that spotting such major turning points in the bull-bear cycle is an impossible task. It may not always be possible to catch the exact tops and bottoms in every bull bear cycle, but there are some time -tested signals that can give sufficient advance indication that such tops and bottoms are close at hand. This knowledge is usually all that is required to ensure investment success.

Under normal circumstances there is no rational reason why any stock market index should appreciate by 100% in any particular year, over the peak of the precious year. Even under the most optimistic of economic conditions, an across-the-board jump in share prices of this magnitude would not be justified by corporate fundamentals. The reasons for such a steep appreciation in share prices must then logically be ascribed to uncontrolled euphoria and the emotional excesses of and over-enthused market to sell, even if your selling decision happens to be premature and dose not exactly coincide with the highest bull market peak.

A bull market invariably scales a major top only when hundreds of thousands of small investors, motivated by dreams of instant wealth, make a frenzied bid to grab whatever shares they can before it is too late. At such times, excitement runs high, emotions replace reason, greed replaces caution and market sentiment is feverishly bullish. Since an individual investor has limited capital at his disposal, he tends to get attracted towards shares that appear to be cheap and affordable. As a result. he usually ends up purchasing shares which quote at around, or below, their par values. These low-priced shares give him the feeling that he is acting prudently and with caution. He also persuades himself into believing that these below-par purchases are genuine bargains which will give him the twin benefits of limiting potential losses and unlimited potential gain. This is the main reason why at a major bull market top it often becomes difficult to find shares which quote at below-par prices.

As a rule-of-thumb, the selling signals flash red when the number of shares quoting at below-par prices falls to around 0.5% of the actively traded shares on any stock exchange. At such times, it pays to sell _and to sell heavily_without giving a second thought to whether one has made the right decision or not. When the market is close to a major top, the shares of closed-end mutual funds tends to quote at high premiums to their net asset values .

Emotions Of a Investor

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Emotions are strong feelings and play a important role in the formulation of investment decisions. Most investment decisions are motivated by greed,fear and hope.
In a bull market, greed is the main motivating force fuelling investment decisions. Investors throw caution to the winds, borrow money at high rates of interest, stretch their financial resources , and take other unwarranted risks. In the bear market, on the other hand, fear is the dominating emotion. Fear leads to panic selling and unloading of otherwise sound scripts at unbelievably low prices.

Frequently, investment decisions are based on hope. An investor may want to buy a particular share because he thinks it will go up, but because he hopes that it will. Hope also sometimes makes an investor cling on to a share whose price is falling rapidly in the hope that it will eventually rebound to its original price. Wishful thinking is another word for hope.
Emotions distort the decision-making process. They frequently override reason, logic and some times even facts this happens especially when emotions come disguised as reason. They prevent investors from seeing reality as it really is , and not what they would want it to be. Emotions also prevent investors from changing their minds when proved wrong, or when there is need to change and adopt a different line of thinking.

Excessive fear, on the other hand, is a dangerous emotion because it can lead to panic selling and prevent the investor from picking up bargains in an atmosphere of doom and gloom..... the ideal time to do so.