The Madness of Markets

By Duru

December 5, 2004


I have wanted to write a piece like this for quite some time. I find investigating and analyzing the market's madness both entertaining and educational (and even occasionally profitable - imagine that!). I am always reminded of how inefficient the market can be at pricing equities as it lurches and spikes in bursts of emotion focused on short-term events. Like a kid seeking instant gratification, the market often loses sight of longer-term trends and developments that are much more important than the day's latest drama.

The charts (from TC2000) below are all recent examples of stocks that first reacted poorly to earnings events only to recover those losses in the following hours, days, or weeks. Use these examples of reminders of why it is important to develop your own convictions about your trades and investments before the market forces you to react in the same trigger-happy way it is acting. Of course, certain trading strategies require you to respond immediately. But just as you should move with the dominant trends when trading on technical grounds, you should at least give longer term fundamentals a moment's consideration before following the previous hour's consensus. If you are looking over the horizon and toward the greener grasses, then these charts should resonate with your sense of indignation at the churn caused by instant gratification.

Certainly, this presentation is hindered by selection bias. I could just as easily throw up four charts where the market's instant reaction stamped a long-lasting impression in the foreheads of any suckers who chose to continue the fight. So, please treat this as an educational tool and not as a proof of any particular market theory! Even more importantly, nothing in these charts should be construed as advice to buy or sell any stock. Final disclosure: I hold a hedged position in OVTI and have held positions in all of the other stocks excluding MCHP at various times this year.

State Street has been trapped in a persistent downtrend all year, and the stock has still not broken out of this malaise. However, the latest earnings report took the stock down to news lows in a very climactic way. That is, volume far exceeded anything seen all year. Unlike the prior earnings report that also featured record-breaking volumes, the stock quickly recovered the same day and went on to recover all losses within a week. Only time will tell whether the sellers have finally capitulated and left the building.

FORM is one amazing stock. It has now hit all-time highs but the road to these lofty levels has been far from straightforward. There is obviously a strong foundation of buyers who really believe in this stock. These buyers have stepped in at very critical moments of late as shown above. If you did not maintain your conviction on this company, the market would have shaken you out several times…and probably destroyed your confidence in the process.

OVTI is the classic "manic" stock. In the moment, the stock seems extremely volatile and erratic. But take a step back, and you can see that it has very strong trending tendencies. Note well the spikes in volume as various drama unfolded. The buyers are slowly but surely wrestling control away from the sellers. You can almost feel the confidence in this company rebuilding.

I have not observed MCHP as long as the other stocks featured in this piece, however, I was intrigued by this one because despite the intense short-term drama that often surrounds this stock, it has essentially gone nowhere for a year and a half. Something told me that the latest drama would generate as mixed a response as ever. Sure enough, after the sellers were done with their usual panic, the buyers stepped up and recovered most if not all losses. Hard to say where this one is going next, but if history is any guide, you can find it here, same bat-channel, in another three months or so. If you are looking to develop some sort of conviction on this one, the key is to figure out what exactly does the market want to hear, and what exactly is it most afraid of?

I plan to do more of these in the near future from time-to-time. If nothing else, I  hope they can help some of you firm up your ability to cope with the madness of the markets.

Be careful out there!


© DrDuru, 2004