Extremes, in either direction, often take on a life of their own. These intense positions are usually followed by even greater extremes as average amateur investors jump on the bandwagon during any extended bull market and bail out near the end of any extended bear market.
However, irrationally priced assets will eventually regress furiously toward the mean and beyond in order to punish the millions of late arrivals to the wrong side of the trade. Gauging the timing or extent of such a move is always challenging. The best you can do is plan for it if you would like to take long positions. Irrational valuations will be followed by nearly inverse extremes. If you are disciplined and patient in your trading, you will end up ahead more often than not. In the past, we at ETF Trade advisor have underestimated the extent to which extremes will go to absurd levels and we are the first to admit it.
In recent months, you will likely have heard from your friends or family members, who are bragging about the value of their portfolios. They have come to the conclusion that with all of the stock market’s volatility, they’re better off continuing on course by adding more to their positions. We beg to disagree.
In early 2000, many investors refused to sell their Nasdaq holdings in the belief that no matter what happened, they would come out ahead simply by being patient and not changing their method. It was the same with 2007.The only difference was that we had widespread complacency in 2007 and in 2000 it was the euphoria of small-caps. In early 2014, we have an especially dangerous combination of both euphoria and complacency.
Whatever instinctively looks most ridiculous and imbalanced in its extremity it most certainly is just that — humans can’t imagine that the future can be very different from the present. Think again.