Fear is beginning to drive stock trends

Since I pointed out that “Investors are Complacent” on November 27th, the S&P 500 index of large company stocks has declined -1.4% and the Russell 2000 small company stock index more than -2%. Both are small declines so far, but it was enough to shift the return driver from Extreme Greed in early November to Fear as of the close on Friday.

S&P 500 and Russell 2000 decline

S&P 500 and Russell 2000 decline

Fear is now driving stock prices. Although, it isn’t yet at an extreme level, I like to point out these oscillations of fear and greed investor behavior because investors feelings are often the wrong feeling at the wrong time. That is, after prices have gone up investors get more greedy and optimistic. Then, after prices decline just a little they become fearful of losing more money. I believe some investors are more oriented toward either fear or greed, but many actually suffer an emotional roller coaster: they oscillate between the fear of missing out and the fear of losing money. That is a real problem when they feel the wrong feeling at the wrong time.

Such investor behavior is also a significant driver of price trends. For example, a waterfall price decline occurs from “Serial Correlation”. That is, waterfall declines happen because prices go down, then down some more, as more and more investors sell because they are losing money. Panic selling is serial correlation: selling occurs because prices are falling. For example, investors lose 20% and then begin to exit their positions to avoid further loss. That leads to other investors losing 25% as selling pressure drove prices down more and they exit their positions to avoid further loss. The nice thing is we all get to decide how much we are willing to lose. You can’t lose 50% without allowing it. This can also be an advantage for robust trend systems designed to profit from directional drifts up and down.

Now that Fear has become the return driver, we shouldn’t be surprised to see prices move back up. However, the investor sentiment hasn’t yet reached Extreme Fear, so all the sellers who want to sell may not have yet sold. The simple Fear and Greed Index dial I use here isn’t a timing signal. Instead, I use it to point out how sentiment shifts from Fear to Greed via a website everyone can see. I actually use other indicators to measure sentiment and counter-trend points. But you can use the Fear and Greed Index to discover how your own feelings may oscillate between emotions.

From this point, Fear can continue and reach a more Extreme Fear level and prices can keep going much lower. However, if the sellers that wanted to sell have sold and prices have declined low enough to bring in new buying demand prices will move back up.

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