The Crash of 2008... Education...
From: Robert Dijkstra (info.robertdijkstra@gmail.com)
Sent: Wed 10/29/08 10:05 AM
To: Robert (info.robertdijkstra@gmail.com)
The Crash of 2008... Education...
By Dr.Alexander Elder
Dear Trader,
We live in extraordinary times. The world stock markets have crashed, and their volatility is unprecedented. Back in the 1970s, when I first entered the markets, the 1,000 level of the Dow was called 'the graveyard in the sky' - any time the market went up to that level, it turned and entered a bear market that would go down 200 or even 300 points within the next year or two. Now the Dow can leap almost a thousand points in a single day, and a 200 point range feels almost like a quiet day.
We have seen severe damage to the price structures of major market indexes worldwide. On some days, as I listen to investors and traders, the feeling of fear is almost palpable. It pays to keep in mind that a savvy trader plans ahead, while a poor beginner jumps in response to emotions - he or she buys amidst the optimism of market tops and dumps shares in fear at market bottoms.
Let us review the current market situation, try to look ahead, and plan for the future. We also must begin thinking about the lessons this crash can teach us. This will take a long time and we will not accomplish everything in a single letter, but there are several points worth discussing today.
To find a parallel to today's state of the world's stock markets and global economy one must go back to 1929 and its aftermath. Those times seem like ancient history to most people, but when I first entered the markets I met guys who traded in 1929 and during the bear market that followed the crash. I eagerly listened to those old-timers and learned from them.
The Crash of 1929 rolled over into a Depression due to two severe mistakes by the Republican administration of that day. First, it focused on defending the US Dollar by jacking up interest rates which dealt a body blow to the real economy. Second, a misguided Congress tried to 'protect American industry' by erecting high tariff walls. It never occurred to those gentlemen to ask how we can expect the world to buy our goods if they cannot make money by selling their goods to us.
The current government is acting quite differently. It reminds me of Sigmund Freud's famous quote: 'the voice of reason is quiet but persistent.' Simply put, I think that the current administration has learned from those old mistakes and is handling the crisis much better. They are pumping money into the markets, supporting the banks, and not allowing the system to seize up. Sure, it feels disgusting that taxpayer money is going into the pockets of those who got us into this mess, but the key point is that trust must be restored so that the system can continue to function. Furthermore, instead of building self-defeating protectionist walls, today there is a remarkable degree of cooperation among finance officials around the globe. We are living through the worst worldwide financial crisis since 1929, but the signs are that we will muddle through a lot better now than our forefathers did back then. We do not expect to see what was a sad norm in the 1930's: a 25% unemployment rate, massive repossessions of busted out farms, and other such Grapes of Wrath stuff.
At the same time, I think we have not yet seen the bottom of this decline. Markets rarely if ever trace out V-bottoms. Individual stocks can do it occasionally, but it would be highly unlikely for the entire stock market to turn on a dime. A violent bottom, like the one we just saw, is likely to be retested a few months later on lower volume. Or rather - we hope it gets retested and then the market reverses, but there is no guarantee that the current lows will hold.
Let us look at a few numbers. The average length of a US bear market is about 18 months. This bear is just one year old, meaning it is reasonable to expect this weakness to last into Spring 2009. And what about the real economy? The stock market tends to lead the economy by about 9 months, although this lead may have shortened a bit, as the pace of life has speeded up. This would seem to indicate another year of continued weakness in the economy. When things get ugly in the economy, interest rates decline further, and almost everyone forgets what a bull market looks like, but that's when the first stage of the new bull market can begin - possibly some time in 2009.
Keep in mind that bear market bottoms present fantastic buying opportunities. Prepare yourself to think of incredible bargains you will be able to scoop up. This is a very important topic that we will be tracking in the months ahead.
And what about the lessons we should learn from this crash? The very first one is that every position deserves what I call 'a catastrophic stop'. An experienced trader may manage a short-term trade with only a mental stop, but every position you plan to hold for any length if time deserves a real stop at a level that one hopes never to see. Two friends of mine bought a stock at $20 that they thought was a bargain, but now it trades at 20 cents. One bailed out at $18, the other still holds it today. At the time he bought he should have asked himself, what level he never expected to see - $15? $12? Whatever it was, that's where he should have put his 'catastrophic stop!'
Most traders have very short memories. They look at recent events and extrapolate them into the future. They feel bullish at the tops and bearish at the bottoms. Long-term successful people possess a knowledge of history and a memory of how things work. They need it in order to do the counter-intuitive thing - sell at the tops and buy near the bottoms.
Make no mistake about it - there are fantastic buying opportunities ahead of us on the horizon. It is our goal to learn to recognize them, time them reasonably well, and have the intestinal fortitude to buy. These are the tasks on which we will be focusing.
PS - one day before this email was to be sent out, a message arrived from one of our clients. I reprint it here, with writer's permission, to show how a serious person takes steps to protect himself in a decline and even to profit in it:
"Dr. Elder,
In the last Bear market, I watched my 401k plummet and didn't know who to believe or trust.
After reading your books, attending your webinars and live seminars I began trading. Not successfully at first, but eventually producing consistent results.
Now, I am trading independently and trusting my own analysis of the chart patterns. This year has been incredible for my trading!
Thank you for sharing your lessons and wisdom. Without it, I certainly would be experiencing the same despair as in 2002.
Kyle Richardson"
Thursday, November 06, 2008
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