How ongoing volatility will shake the stock market

Two weeks ago bears suffered one of their most crushing defeats in years. Make no mistake, this has been and continues to be a shoot first and ask questions later market. A lot of people made some big wagers that Europe would go down the drain. No sooner was the ink dry on their settlement statements were they at it again last week. As last week started we were greeted to a round of intervention by Japanese which threw the Dollar into rally mode which created an inverse relationship pullback for the equity markets. You’ll recall the prior week a deal was struck in Europe and my favorite media center was playing Zorba the Greek bumper music. So even before the referendum sequence markets were looking for an excuse to drop. That’s why the shorts did initially have the wind at their back.

You have to hand it to Mr. Papandreou. In one fell swoop he did for traders what it may have taken us days or weeks to accomplish on our own. Yes, his attempt at referendum totally eliminated all euphoria from the prior week. It’s hard to remember this concept in the heat of the moment but if you get nothing else from these columns remember the following:

In bear phases it takes days or weeks to get the kind of fear required to bottom out a market. In bull phases it happens very quickly. Wasn’t it 3 weeks ago the VIX was up near the 36 level and by the time the European deal was announced it was down near 26? Last week it was right back up there. Not only did we have to deal with the backroom political intrigue, we also had the MF Global situation to deal with. The feds will launch their own investigations but if what I’ve heard is true, that they allegedly dipped into clients’ money, Mr. Corzine will have accomplished another landmark psychological event.

We’ve discussed Bernie Madoff in this column and while I am in no way comparing Mr. Corzine to Bernie, in addition to everything else their actions will have eroded the public confidence in trading and investing in financial markets. In Mr. Corzine’s case, according to an AP story an MF Global executive admitted they dipped into client money but until an actual crime has been proven in a court of law we’ll leave it at that. But if proven true, it will have accelerated the process and fast tracked us through the corrective process of whatever this bear market has left.

Back to Greece. Traders went out and shorted the market again on word that a referendum in Greece would be called. The prevailing wisdom was the good people of Greece in no way would approve such a scenario. But here’s where an understanding of psychology and emotion is so important. What trader really understands the political backroom intrigue of a small country thousands of miles away? What was Mr. Papandreou really trying to accomplish? My layman understanding of the situation is that what he was trying to do was get the opposition in the same room so he could win a confidence vote. Did anyone really think the people of Greece were going to get the opportunity to vote for AUSTERITY? What it really came down to is whether Greece wants to secede from the EU. Faced with that vote what would the Greeks really decide?

Nobody really knows. I’m not here to give you a lesson on Greek politics. What I am trying to say is we had another knee jerk reaction from bears who are not very convicted on their views in the first place as evidence of the prior week. As it turned out, as another AP story hit the wire Thursday morning, bears were getting squeezed again as the NQ skyrocketed sky high. You have to consider that in the very short term, these ultra-bearish days are going to happen but you can’t take it at face value. You have to consider that the crowd is wrong. I know it’s a hard thing to do but to survive you must.

What can you bank on? In a market like this, the only thing you really can bank on is being a keen observer of events from day to day. Feel the emotion like everyone else but take a step back and interpret it. I told you in this space I am very concerned about a market that goes up only when bears give up their short positions. I need to see legitimate buying come in. How will that happen? When bears stop shorting the bad news. The market is starting to show some resilience because as of Sunday night the NQ had recovered much of the losses sustained from bear’s referendum short play. When markets no longer go down on sour news will we know we are on a better track.

Next page: What to expect...

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