To Hell With Risk

If you have learned the story of the legendary trader Jessee Livermore, then you would know he made an absolute fortune shorting the market during the 1929 market crash.  But, what most people do not know was that his success went to his head and he made bigger and bigger trades without recognizing the risks, and ultimately died broke and committing suicide by a self-inflicted gun-shot.  The lesson one should walk away with is risk is a double edged sword and must be wielded wisely.

Yet, today, it seems many are completely oblivious to the risk inherent in a parabolic rally such as we are currently seeing.  I have seen a number of articles and investor comments outlining how this rally simply does not make sense to them.  Yet, I have seen even more proclaiming that we have entered a new paradigm and there is no end in sight for this rally, as they come up with every “reason” in the book to support their desire to be aggressively long this market.

Remember what I noted in the weekend update regarding psychology:

 “Yet, we continue to assume this time will be different and the latest shinny object upon which market participants are focused is the reason why the bull market will continue unabated.  Of late, that happens to be artificial intelligence. Could this time be different?    Could we finally conquer the natural cycle of human nature? History suggests that we cannot.

Yet, how do we continue to fool ourselves over and over again?  In fact, as I have outlined above, this cycle repeats through generations, as one generation does not ever seem to learn from the prior generations.

I propose that the main reason is because we believe we are more rational in the present, whereas we view those of the past as being inappropriately emotional.  We look back and say to ourselves, “how could they not have foreseen what was coming?”  So, we assume we are smarter than our predecessors. We assume that our rational brain is appropriately guiding us and that our result will clearly be different than the lessons of the past.  Yet, while we believe that we are rationalizing to attain this reasoned perspective, many recent studies of how the brain works tell us otherwise.

Much of today’s research indicates that the primitive emotional brain (the limbic system) processes information and makes decisions significantly faster than the rational prefrontal cortex.  As Douglas Noll found in his 2025 research, the emotional brain processes data five times faster than the logical brain, selecting a choice well before the prefrontal cortex even processes the relevant information. A recent Standford study noted that 90-95% of decisions are shaped subconsciously by the emotional brain, and not by logical reasoning. These, and many other such studies, support the proposition that emotions drive our primary decision making, while rational thought simply justifies those emotional choices after the fact.

I find it quite interesting that the recent psychological studies of the human brain support a perspective set forth through one of Ben Franklin’s pithy, but wise, declarations uttered centuries ago:

“So convenient a thing it is to be a reasonable creature, since it enables one to find or to make a reason for everything one has a mind to do.”  

And, when we apply this perspective to financial markets, we must recognize that decision driving emotions are strongest at the high and low points, right before major turns occur. That means that the strong bullish emotions which are seen at market highs convinces us that we will go much higher, which, in turn, drives our buying behavior.  We then rationalize why we are certainly going higher to support our subconscious emotional decision.

At the end of the day, it is our primitive brains that cause investors to buy high and sell low, as those decision driving emotions are strongest at the various market turning points.”

So, as an analyst who takes his responsibility to his clients very seriously, I feel compelled to make sure you are objectively seeing the risk.  

When I look at this rally off the low struck at the end of March, I see a rally wherein we are approaching the 3.382 extension of waves i-ii off the recent lows.  While this is not unheard of the world of commodities, it is highly irregular in the equity market.  And, what that means is that risk is seriously inflated.  Yet, I keep going back to the term coined by Howard Marks – perversity of risk, wherein those involved are simply unable (or unwilling) to see the significant risk inherent in a rally of this type.

Yet, that does not mean it has ended.  In fact, as I outlined in the weekend update, until either the IWM breaks below its wave ii low (276.10), or it gives us that 5^th wave rally to 294, I cannot assume this seriously extended rally has yet concluded – and, yes, can still extend even further.  But, if you are indeed trading for that 5^th wave higher, PLEASE recognize the risk inherent in doing so, and make sure you have a solid risk management plan in place.

There is another point I want to add to this update, and I have already made it in the live video I did for the full membership earlier this morning.  I have included my daily chart in this update to outline this point.   Due to how large this wave 1 in the blue count would be, I had to extend the expected target for the blue count to the next Fibonacci extension higher.  But, again, I have to warn that it is ONLY applicable if the market provides us with that 1-2, i-ii set up.  The more this extends, the less likely I see that potential, as this is already acting like a blow-off top which has signified many prior major market tops.  Yet, I must remain open to that potential, and will indeed deploy my own cash should that set up develop in the coming months.

In summary, I want to again stress the significant risk that is inherent in this type of rally, and urge you to have your risk management plan set for action should we see a strong reversal.  Moreover, I want to reiterate that, even though I do not see it as the most probable path going forward for MANY reasons, we must also keep an open mind towards that blue count.  And, should the market provide to us that set up in the coming months, then we would have a lower risk set up in which we can invest and ride the market to 8000+.  But, an objective view of the market must recognize the serious risk right now, and also recognize the potential opportunity if we get it in the coming months.