Monday, November 9, 2009


Tonight I wanted to explore a behavior that is as old as the markets...fighting the tape. There seems to be quite a bit of this going on lately, especially since the market broke through 875.

Now I'm talking about perma bears trying to pick a top but this behavior is not exclusive to bull markets & perma bears. Hardly! Fighting the tape is one of the reasons bear markets can do the terrible damage that they do. Perma bulls jump on every rally in a bear market looking for a bottom that never comes. Well it never comes until the last bull is broke.

Bull markets are the same. They continue to take money from the bears day after day and month after month until there are no bears left solvent. Once that happens the bull market is over.

So why do investors choose to fight the tape? Let's face it if we could simply control our urge to trade against the large trend we would have very few losing trades. Why? Because as long as one has a little patience every trade in the direction of the major trend is eventually going to get rescued when the main trend resumes.

It's such an easy concept but one that just seems almost impossible for many traders to follow.

My best guess is that traders have a bias that they aren't willing to let go of, often based on their view of the underlying fundamentals. They take a trade based on those fundamentals, real or imaginary, and then when it goes against them they start to rationalize why the market will soon come to its senses. Often they make the unforgivable mistake of adding to losing positions.

I can't even begin to tell you all the nonsense I've read over the last several months. All of it useless for anything other than convincing oneself to stay in a losing trade against the major trend.

Let’s take the recent cyclical bull market as an example. Since the March bottom we've seen 24 up weeks and 12 down weeks. By being short in this environment the odds are stacked against you 2 to 1 and considering the up weeks have gained a tremendous amount more than the down weeks the true odds are probably closer to 4 or 5 to 1.

If you were playing Russian Roulette and the gun had 4 bullets in it rather than 1, would you still play? Just kidding I trust no one is that stupid. However there are literally millions and millions of investors that are playing Russian Roulette with their portfolios when they fight the trend.

Now let's say you have a mechanical system that puts the odds more in your favor. The Bollinger band crash trade does exactly that, especially in a bear market. The reason being is that the largest rallies tend to come in bear markets. However the same can't be said for bull markets. I know of almost no mechanical systems that effectively short bull markets. So in this instance mechanical traders may have a bit of an advantage trading against the trend in a bear market as opposed to a trader trying to find a mechanical approach to shorting a bull market.

I did develop one mechanical Bollinger band short trade several years ago but even that probably doesn't have a positive expectancy even though it does tend to have a high win rate. The problem is that the few losers are so large they overpower the many small winners.

The only tool I've seen that really has much success shorting a bull market is cycles. And even then they only succeed if the cycle manages to stretch into the very latter part of the timing band. If not then you run the risk of shorting too early and having to endure a final leg up that blows out your shorts.

So even cycles are only rarely dependable at signaling profitable shorting opportunities in bull markets.

If only investors could resist the urge to fight the trend most would actually make money in the markets.

So why do we fight the tape? What say ye?