The Human Ups And Downs Of Market Mania

Lest anyone thinks it is just large-cap tech stocks that are trading to Jupiter these days, the chart of small-cap stock prices (the Russell 2000 index below since 2001) shows an incredible 40% gap above their 200-day moving average. Sven Henrich points out in Signal Fire, never before has the weekly chart seen such a steep disconnect, and there is no historical incident where prices have not eventually reconnected with their weekly 50 moving average (blue line below).

A simple reconnect from present levels would mean an average price drop of 31%, and as Sven points out, “…it’s rare for it not to happen for more than a year.”

A similar pattern is evident in U.S call trading volumes, which have never been higher, as shown below in this chart since the market top in 2000 courtesy of Bloomberg.  Retail is in the house!!

As J.P. Morgan famously remarked: “Nothing so undermines your financial judgment as to the sight of your neighbor getting rich.” 

In the midst of manic market cycles, it is very human for one to imagine in retrospect where one ‘could have bought’ and ‘should have sold.’ In reality, speculation is much more complicated, attention diverting, peace-destructive, and financially dangerous for individuals than commonly understood. The vast majority of people end up worse off in the end, and this reality is consistent through generations of experience.

While all the classic errors are widely evident in young and inexperienced participants today, other folks, who should know better, are also perpetually at risk of succumbing to the seductive impulses of our lizard brain.

Just one example is the classic behavior that overtook the greatest mathematician then alive, Sir Isaac Newton, during the South Sea stock bubble of the 1720s. Especially today, it’s important to review such precedents and be reminded of why firm rules and risk-management are essential to real-life outcomes. Read Investors have been making the same mistakes for 300 years. Here’s a taste:

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