Dear Trader,

Do you know what the MOST important chart for you to understand is?

It’s not QQQ, it’s not the S&P, it’s not even $VIX. This is something ive been dragging my feet on a bit because we talk about it so much but ive come to realize that just talking about something is not always enough to help everybody grasp something so important.

This isnt just a normal stock chart, it’s something so much bigger than that.

I’m talking about the Sentiment Cycle Chart.

Today being Technical Tuesday means it is time to do some teaching. I want to dive into what the sentiment cycle is and why it is so important in the market.

Are You Actually Bearish?

Everybody has been talking about how this could be the bottom… listen to the analysts, watch the news, watch the headlines, even in my community people are starting to think that we are on the floor of the market.

This stuck me as a bit odd, when you look at the polls that are out in the world the general consensus says that people are bearish in the market right now. There is a difference between being bearish and acting on your bearishness.

If your account is sitting in cash right now you shouldn’t look at yourself as bearish, you are really just neutral. Youre not looking for the market to go up, because you’ve got cash, but, youre also expecting it to go down.

The difference is really whether or not you are putting your money in the market and positioning yourself for the market to go down. That is why we look at the put call ratio, it is telling us when people are putting their money where their mouth is preparing to profit from the markets free fall.

The Market Has A Process.

The process that the market goes through is controlled by the psychology of the investors. We need to understand what they go through, their feelings, and the sentiment of the market.

Really, it dosent matter if the market is going to zero or to the moon investors will always fall somewhere in the four emotional stages I am showing you here.

Let’s zoom in a bit and break down each of these stages one by one before I tell you where I think we actually are in today’s market.

  • Euphoria

At a market top like we saw last November you will experience euphoria. Investors start to think that nothing can possibly go wrong in the market.

Some of you may know my story about the cab driver I had in 2001. I told him I was going to be on CNBC and as soon as he found out he started rattling off stock picks to me saying I should talk about them. This is a sign of euphoria. Any random person will think they can throw money at the wall and see a profit. Yea you might get lucky and take a win that way but it has no longevity and won’t allow you to scale your trading.

Euphoria is actually bearish for the market. When everybody is in the market buying left and right it pushes us to an extremely over bought and selling pressure is at a high. All it takes when everybody is fully invested is one little rattle or shake in the market, people were already considering taking their gains and running to the bank, any little push forces the market to roll over and start trending down.

This has a compounding affect group one sells, the markets falls. Group two sees the decline, gets scared and sells. Group three is late to the game and starts taking losses. Group four is left holding the bag.

  • Disbelief

This is where investors try to talk themselves into a safe place. They tell themselves we are not going into a bear market. Because we are all human here (except Brandon, nobody is that happy all the time) we try to justify staying in a position.

There are all sorts of thought investors and traders have during a period of disbelief. They say things like “it’s just a small dip” or “the markets are strong they are going to make a run again”

We will even be having these thought when the technical indicators are in disarray.

The technicals are what you need to be watching, when the market is in disbelief we have to remove all emotion from our trading. We can be a bit care free with our emotion during a solid bull run but before that transition we need to batten down the hatches and rely on the hard data. That is the one thing you will always be able to turn to for the right answer.

  • Acceptance

During the acceptance phase everybody starts to throw in the towel and say “forget it, we are in a bear market, I need to get out and preserve what retirement savings I still have”

This is when we start to see massive sell-offs take place. This will force the markets down lower and lower regardless of how much the markets fight to pull up.

The acceptance phase is on that we will not walk into on our own. We will not go gently into that good night. This needs a trigger to force us to understand what is going to happen next. That might be the Fed, it could be earnings, or any number of other triggers that push us over the edge.

For the ignorant this stage gets messy, for the unwilling this stage is devastating, for you… it’s a great chance to see some extraordinary profits.

  • Despair

This stage is kind of the class clown of the group. It is a time that nobody wants to buy a stock. People tend to be a bit skittish at this point, they have lost a lot of money and refuse to think the markets will ever come back.

I’m going to let you in on a little secret, it has always come back.

The stocks have hit their bottom at this point. We will be sitting on the true floor of the market, it’s the buy-the-dippers wet dream, nowhere to go but up. This is the first stage of the market that actually transitions us into a bull market.

And you know what, when we make it past the acceptance phase and we reach despair my Penny Nation and Night Traders are going to be using the exact same indicators to ride the wave back up. That is the beauty of technical trading, no matter what moves the markets make the data will tell us exactly what is to come and how to trade it. That is why it’s silly not to be a part of the crew, we are learning to trade during hard times so when we transition next it will be easy sailing and you’ll know how to respond to the markets being reinvigorated and I will be there every step of the way.

What Stage Are We Currently In?

If you explain this concept to 1000 people and ask where they think we are at today, you’ll get 1000 different answers.

If you ask me, I’ll give you the truth.

We are currently in phase 2 disbelief. We can see that by the headlines and analysts saying the market are going to make another run. There is bounce after bounce giving people their regular dose of hope but there is no way we have hit the acceptance phase yet, the drop in the markets have been minimal compared to what the next phase has in store so just trust the data follow the trend and you can come out of this mess with full pockets and a smile on your face knowing you trusted the process.

Talk soon,

Chris Johnson
Quantitative Specialist, Penny Hawk


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