Bull traps lead to bear market losses
The stock market’s rise looks reassuring and exciting. In only two weeks, it regained over one-half the ground lost in the three-month selloff. However, that observation contains the warning that another, deeper selloff leg could happen soon.
First off, look at the stock market picture. The August-October selloff had many negative signs along the way. (See my previous write-ups for explanations.) Then came the last two weeks, with indicators that are likely false positives, as discussed below.
S&P 500 daily moves from June through Nov. 10, 2023
The problem is that the start of a new bull market takes time. Investor attitudes need to improve by “climbing a wall of worry.” It’s the false reversals that zip when a selloff pauses. Such reversals, if dramatic enough, can then develop into “bull traps.” These loss-causing actions result from enthusiastic, optimistic buying that goes awry when the selloffs suddenly return.
Why “trap?” Because when the rise experiences the first downside reversal, it is seen as a new buying opportunity. Then, when the rise fails to resume, the realization comes that the old selloff has returned. Thus, the investors get trapped by the distressing choice of either selling now at a loss or holding on and risking losing more later.
Note that human nature, once again, is behind the mistaken views and actions. The following descriptions explain bull trap and human nature’s role well…
From an article in Finance Strategists (Sept. 7, 2023): “Bull Traps”
“What is a bull trap?
“A Bull Trap is a false market signal indicating a reversal from a downtrend to an uptrend in a financial asset’s price. This deceptive signal leads investors to buy, anticipating a market rise.
“However, the asset’s price declines soon after, trapping the bullish traders who bought in anticipation of growth that never materializes.”
…
“With today’s fast-paced, interconnected financial markets, the prevalence and impact of bull traps have increased due to rapid swings in investor sentiment.”
“Role of Market Psychology in Creating Bull Traps
“Market psychology plays a central role in the formation of bull traps. Investors, driven by fear of missing out (FOMO), may jump onto the perceived upward trend without adequately evaluating the market conditions.
“This rush to buy can accelerate the price increase, further fueling the perception of a bull market. But when this optimism is unsupported by fundamentals, the correction can be swift and severe, resulting in a bull trap.”
The bottom line – Stock investors were not bearish prior to the rise
While some articles proposed that notion and worse (panic!), surveys barely showed worry. In fact, the very good weekly US Advisors’ Sentiment Report showed a healthy 50% bull / 24% bear reading as of October 24, just prior to the upside reversal. November 7 was similar. Most likely, the November 14 reading will be even better.
Additionally, the fast two-week stock market rise confirms that low worry attitude. If investors were truly concerned, they (and the media that tend to mirror investor feelings) would still be wrestling with the negatives. Moreover, the market would be see-sawing and slogging its way through a turnaround (but only if fundamentals were supporting such a move).
Therefore, don’t take this recent rise as an indicator of better to come. If a bull market truly is starting, there were be a crooked path ahead. All those negatives that are still with us need to be flushed out before we can have a galloping, runaway, fad-driven bull market again.
