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The Smell of Fear & Food For Thought

 When my wife and I first talked of having children, we had always assumed that we would have a girl.  This was exciting for my wife because she dreamed of being able to buy cute clothes for her little girl, put bows in her hair, and looked forward to a future of going shopping together with her daughter.
When she first became pregnant, she went on and on about having a girl, then her family chimed in.  Everyone in her family claimed that “they felt’ she was going to have a girl.  Soon, it spread to my family who then broadcasted over and over again about having a little girl in the family.
Now, about this time is when I began to question this line of thinking.  Why?  Because when everyone becomes an expert and acts as if what they profess will come to pass, I tend to get nervous.
I stepped forward and let it be known that she was going to have a boy.  You would have thought I spit on the Virgin Mary or something.
How dare I say she was having a boy?!!  She was the one carrying that baby and she knew she was having a girl!
Then, the doctor took a sonogram and told her she was having a boy.
Nobody could believe it, except me.  My beautiful wife and family were still exclaiming that the doctor could be wrong, everyone recited stories of mothers who thought they were having a boy but ended up having a girl instead, and, hey, what did doctors know anyway?  They could be wrong!  Lots of doctors are wrong, right?
Well, in February of 2006, young John Zachary Williams came into this world with all the potential and promise of a strapping young baby boy.
That said, the lesson is that crowds are wrong.  Not sometimes, but the majority of the time, if not all the time.
And this is why you need to be suspicious of the stock market all the time.  When people start declaring bull runs that never end or the death of investing in stocks, you need to be suspicious.  Investors move together in herds in that they reinforce each other’s perceptions no matter how false those perceptions are.
This is why otherwise intelligent people do dumb things – because they are in a dumb herd.
How does this happen?  Because people lack the willingness to confront unpleasant facts such as trends end, what comes up must come down, or all things must come to an end.  Every crash burns the investors that don’t want to confront the fact that their stock, which was once trading at $300 a share, now trades at $270 and is falling.  Ignoring their stops, they justify their behavior by rationalizing that they will sell when it gets back to $300 despite facing the fact that the market as a whole may be breaking down.
This is why rationalization can be called the evil twin of denial; the inability to confront the facts by denial + then rationalizing your actions = broken hearts, hurt feelings, and poverty.
What’s the cure?  Awareness.
Practice being aware of what is going on in the market and challenging your assumptions.  Are you long European stocks?  Why?  What if you’re wrong?  What will you do if your best assumptions turn out to be wrong?
Right now, the markets are experiencing a big run-up, tremendous volatility (i.e. 1,000 point drop in a day in the DOW), and huge fears about the debt crisis affecting Greece.  
What assumptions do I have about how Greece affects the markets?  Not sure.  Don’t think anybody knows how bad it is so I’m looking at ETF’s in commodities and options in the U.S. market with an emphasis on watching the intermediate trends.  The trend remains up in the overall market but if it breaks down I’ll begin shorting with put options.
What if I’m wrong?  That’s why I’m emphasizing using option spreads;  worse that happens, I lose a little money but still stay in the game.  
What will I do if my best assumptions turn out to be wrong?  If things go bad, then it could worse than anything we have ever seen before.  That said, it could also present the biggest opportunities we’ve ever seen before too.  I’m playing the trends in the market where they exist but being defensive be taking quick profits.  I’m looking for segments of the market on a global scale for things that are out of favor (being a contrarian again) in the pursuit of value.  
Always think strategically and you will be a more successful trader/investor.  Chance favors the prepared mind, so start preparing strategically now.  If you don’t, you could experience a “bumpy” ride.  If you do, then you put yourself in a position to win big.

Disclosure: None