Monday, May 7, 2007

It's the Psychology, Not the Fundamentals

From the CBS Marketwatch Blog:

"We do indeed seem to be entering, in global terms, a period that is strikingly akin to the week, months and years very like that in the late 80's in Japan when that market 'went parabolic' to the upside. Why markets 'go parabolic,' is not a subject given to business school doctoral dissertations, for there is usually no real fundamental reason for them doing so. Indeed, there is every reason for them not to do so for prices move to levels that are simply unjustifiable in any terms economic. That matters not, however, for the psychology of the market trumps all other concerns and the quicker one learns to accept that fact the easier it is for one to deal with, trade in, profit from and eventual remove oneself from the events that shall transpire. Markets are psychological animals rather than economic ones...a lesson hard for many to learn. This market, however, is now at that point where psychology does indeed fully trump economics.

This is something I have grappled with as well -- how the market can move higher in the face of a slowing economy. I dealt with it a bit in this post where I essentially argued the market is reacting to itself rather than the economy. By itself, I am referring to the prevailing trend combined with the massive liquidity of all the recent M&A deals going on.

However, I think the best explanation still comes down to the old trading rule, "the trend is your friend." Right now we have an upward trend that has been in place for a few weeks. The longer it stays in place, the more important it becomes in traders' minds.