Greed Cycle

Extremely greedy behavior in the markets is usually the prelude to a market top and what can turn out to be a severe bear market where prices fall for extended periods of time. Here are some signals that indicate greed cycles:

The market can’t seem to be stopped. Every day prices go higher and higher, and when a pullback (decline in prices) occurs, it doesn’t last very long; buyers step in to buy stocks with every price dip in shares.

The prevailing sentiment is that this time is different, that you’re in a new era. In the blow off (price behavior that goes straight up) that Figure 8-1 shows, the biggest story from TV pundits and experts everywhere was that Internet companies didn’t need to make money because the concept that Internet stocks would never fall was so endearing that many truly believed that buyers would always be around to support the price of the stocks. When have companies not needed to eventually make money in order to keep up their stock prices? In other words, if it’s too good to be true, it is

Charts develop parabolic patterns. Prices go straight up, such as you see in Figure 8-1, where I marked “blow-off phase,” and when prices crack, they go down fast and hard. Figure 8-1 clearly shows that even though the Internet bubble burst in the year 2000, by 2008 prices hadn’t recovered even 50 percent of their all-time highs.

Blow-off phases are rallies that you can’t afford to miss, even though your gut and your charts should be telling you to be careful. Still, you’re a market timer, and you should be able to recognize these price patterns, as well as the fact that blow-offs can make you a lot of money. But blow-offs are periods of totally insane behavior. Be careful and disciplined; follow your trading rules and follow the advice of the indicators that I describe in Chapter 7.