Markets yesterday were set up for a major disruption: New quarter, earnings season, a blistering Q1 and an overbought condition. What we got instead was a low volume, 1% correction.

Whenever we are at an important market junction, I like to wargame a few scenarios:

• What would the markets be doing if this was a major top? How would trade progress, what would the internals look, what sort of sentiment conditions would we have?

• If this were a modest correction or consolidation, what characteristics should/would that have?

What do you see when you look at the markets during yesterday’s selloff? Lower than average volume on SPY, a big drop off in Nasdaq volume, an uptick in VIX, 5 to 1 Decliners versus Advancers, 3 to 1 new Lows vs Highs, 8 to 1 on declining versus advancing volume. Markets rallied back from their lows, closing significantly off their intraday bottoms. Some significant charts do show some trendlines breaking (or close to it).

To me, that looks more like what I would imagine a consolidation should look like, and less like what the start of crash might be.


Funny, following the Bears Need to Put Up or Shut Up post, I have been getting into some odd conversations with traders (and ex-traders). Yesterday, I got into it about the nature of trading versus investing with someone Paul Kedrosky calls “a prattling gasbag of idiocy.” As far as I can tell, this person has been Bearish for about six months, and was pounding his chest about avoiding a 1% decline — after missing the 24% rally since October 2011.

It was as extreme a case of confirmation bias as I had ever seen.

And that is my personal nightmare. I spend a lot of time looking for opinions contrary to my own, forcing myself to read a different views to specifically avoid that sort of bias. Sometimes its painful to fight my way through them (Thank goodness for Dougie — he makes reading an opposing point of view a pleasure).

We are all subject to Human biases, cognitive fallacies and investing errors which make investing such a challenge. We can try to be enlightened about these negative tendencies, hardwired though they are into our very nature, and overcome them. But without even an awareness of these limitations, our investing is doomed.

What are you doing about your own inherent biases?

Category: Markets, Psychology, Technical Analysis

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

46 Responses to “Consolidation versus Crash”

  1. nofoulsontheplayground says:

    Regardless of what someone thinks the market should be doing, they need to trade or invest according to what it IS doing.

    The internals are pretty short term oversold. It looks like we will still consolidate some more today off the overnight lows and possibly re-trace some of the drop. However, the entire action since the jobs release last Friday looks like a bearish consolidation.

    Ultimately this drop appears to be nothing more than a test of the prior shelf at SPX 1370, although a dip to 1350 would not be out of the question.

    Of greater concern to me is how the NDX handles the 50% re-trace area from the 2000 highs to the 2002 lows. It nearly hit that last week at the highs.

  2. Rightline says:

    I constanly adjust my information filters to offset my biases. Exposure and understanding to opposing views is important. However, avoiding absorbtion and getting sucked into bad thought processes is key for me. Awareness and recognition remain paramount.

  3. Petey Wheatstraw says:

    Heeding the wisdom of old sayings, being very conservative with my resources, staying true to mine own self, and minding the long-term interests of my family.

  4. yogiberra says:

    Markets need to correct and consolidate, buying stops when the energy runs out, the consolidation is a re-charging of batteries, it is during these times that the bears get there chance to have a go, if they cannot push it lower then the upside comes back in to favour. – It is the bears having a go, and the bulls retreating which recharges and provides the energy to re-charge the batteries. – It is never cut and dried at these times.

    Interesting post about the SPX consolidation comparing it to some previous consolidations in recent years

  5. dead hobo says:

    BR wondered:

    What are you doing about your own inherent biases?

    I frequently run these mental exercises and see if anything new rattles out. Here’s a few …

    * The gold nuts might actually be right??? (No, they’re still nuts but they can be useful indicators for all out rallies. Gold is more like a deity to these true believers.)

    * Magic charts really work??? (No, short term charts are useful like business graphs that communicate a lot in a picture, long term charts are only history that reflect the current events of the time. They don’t cause the current events of bygone days as technical nuts imply and sometimes appear to believe.)

    * Business reports aren’t mostly incompetent? (The good ones state just the facts. The shills and posers just relay press releases, provide forums for commissioned sales folks known as asset managers, and support their advertisers.)

    * Experts really exist who know all, but prefer to live like monks so we can benefit from their wisdom and make money from their insights. (If that sounds true, then passbook savings is the best investment available for me.)

    * Whatever happened to the Bodine Quants who were masters of gozinta math? They haven’t been around much since about 2008. Maybe some are working in the fast food industry, having believed a lot of their own shit by mistake?

    * Cognos is right about things (See, I am flexible. He finally won out and merits a read when I see his name.)

  6. Old Rob says:

    Very inspirational post. Overcoming one’s own experiences to find a more unbiased perspective is exceptionally hard to do; no matter if it is politics or economics. Right now, I am scared about the economy. I have heard it is improving somewhat, but by own ‘bias’ is that it is on props. I suppose one can make money in that environment, but it is tough discerning reality.

  7. scottsabol says:

    As a meteorologist (focus in physics and math), I search out articles/publications on climate science that differ from my own scientific viewpoints. As much as its a shot to the ego, reading science that is contrary to my perceptions opens my mind to other possibilities. In many instances, I have either incorporated contrary viewpoints into my own or performed an about face.

    After allowing ones pride/ego to take a hit and you’ve overcome the mental roadblock, the result is definitely refreshing and enlightening

  8. VennData says:

    If our system was a meritocracy, then it would be difficult to have not just one “a prattling gasbag of idiocy,” but an entire mediaverse of them.

  9. A says:

    Generally, I suggest to people that if you do not have an investment strategy (read: plan) that you’re working with, virtually anything will work for you. You get what you deserve.

  10. jackjames77 says:

    I only recently read this book, but it was very relevant to this post. And written so long ago!

  11. Herman Frank says:

    Cash is King, and the tail-risk is what worries me most! What good does 23%+ do me if I’m not fleet enough to get out of one investment class and move into another (so after “making” 23% I see the markets tank to barely break-even)? We gave up on “reputable” investment advisers when I calculated that their commission was higher than the earnings on the deals they did for us (No answer to our question why they would propose / do such deals for us). We don’t have tax-deductions to mention, so any and all income gets whacked by the income tax. (No, I’m not a hedge fund manager with carried interest!) OK, there you have it! We’ve saved our whole life, we’re working and living frugal. We’re happy with what we have, and if something breaks down we have it repaired or just buy a new substitute … with the savings we have. All that stuff about “inflation will eat your savings”? Bollocks! A flat-screen went from $4K to $800, a house went from 100 to 45, Southwest made sure a ticket went from $800 to $75, etc. etc.
    I’d rather be master of my own frugal life than financing the bonuses of Wall Street wise-guys.

  12. krice2001 says:

    “What are you doing about your own inherent biases?”

    Trusting you…

  13. adid says:

    The market had a few good opportunities to sell off hard since the end of March but afternoon traders saved the day each time.

    So, this does not look like the beginning of something too ugly until now, but I think we are in the middle of a 100 points SPX correction – nothing out of the ordinary in a bull market.

  14. Expat says:

    I teach this kind of thing to my students, yet I find myself clicking on articles based on headlines which coincide with my own views. Much of the time I berate myself and actively seek out stories which run contrary to my biases, but far too often I am complacent and happy to read things which comfort my own views. We all need to make a hard, conscious effort to avoid confirmation bias.

    Still, I won’t go so far as to watch Fox News regularly. There is a difference between seeking contradictory views and joining the parade of asshats who pray to Hannity.

  15. Mark Down says:

    Vaca week ..nutin happening until next week !!!!

  16. AHodge says:

    we all start out thinking we know too much
    if you think about it
    id say over 80% of the basic trading rules
    are basically designed to protect you from that, follow them
    stop out your losses’
    take a third off the table on an option triple, play for free
    dont fight the trend
    second be afraid be very afraid
    the people that last in this business tend to be cramped gloomy pessimists
    the last one i want to even talk to is a big blowhard salesman
    talk to a short seller they see the flaws,
    but ideally you need a savvy one who knows the market will go up most of the time

  17. AHodge says:

    if you read soros real time experiment in the alchemy of finance
    only the text not the charts
    its a litany of one mistake or partial mistake compared to perfect knowlege
    its only near the end he reports that it was his best year ever
    made about 100 big ones, in much more humble language of course.
    that kind of humility is what it takes

  18. Conan says:

    First off I trade and am not a buy and hold investor so it is important to know how long you intend to hold an asset before making an investment. I like to use math to give me my signals. it is cold and has no opion, just the paremeters that it was set up with. This method has dramatically improved my results in the last few years and is an on going process to refine and learn from it, but it is designed to be logic based and not swayed by feelings or hunches.

    Too much trading in my experience is detremental to the bottom line. For me the more hunches or pundent driven the more trading there was. So this way keeps me more focused and systematic. You need a clearly defined and tested reason to buy, sell and stop postion. It’s not perfect, but easier in the long run and keeps you focused on what the market is saying which is where the money is at!

    Based on my current model using the S&P 500 as a proxy for the market I went long the first week in January and met my profit goal in March and cashed out. However the signal is still bullish, thus no reason to go short, yet.

  19. AHodge says:

    thirdly I ll tell a story
    the big guys on the street like to get together and brag how much they lost
    thats right i said lost
    this shows the BSD they have– is the mgt and lines to back themselves up
    and the nerve to stick through it
    never take on so much risk that you have to panic stop
    a crazy market can last longer than someone in too deep
    its actually not so crazy
    its looking to take your cryin like a pussy money.

  20. Bill Wilson says:

    I like to take positions around moving averages, because it gives me a place to cut losses. Right now, I think this is a good place to go long with a stop around 1370 on the S&P.

    I’m a believer in cutting losers quickly, and letting winners run. As much as like to think that I’m smart, I’ll admit that every winning trade I’ve ever made could have been a lucky guess. If a random guessing monkey can be right 50% of the time, someone who thinks they know what they’re doing will be right less than that. That’s why I try to admit that I was wrong quickly, and keep my losses small.

    I think this will be another year to sell in May and go away, but it’s not May yet.

  21. george lomost says:

    When my wife and I watch something on tv she will occasionally exclaim “I want that kitchen!” or “I want that living room!” She gets annoyed when I remind her that these are props, not real kitchens or whatever. When you pass through Las Vegas, you can also see simulacra of the Eiffel Tower, Taj Majal, etc.

    Barry, you and your fellow money managers make a very nice living doing what you do. As long as you all act as if the Eiffel Tower in Vegas (Bernanke-managed manipulation) is the same as the one in Paris, France (prices due to actual economic conditions), this whole monstrosity will creak along. Don’t worry, the inevitable crash won’t happen for a bunch more years, but break it will someday.

    If it weren’t for the fact that my and my family’s savings are being destroyed to prop you up, I wouldn’t give a damn, but they are, and our great country too.

    Your “Whenever we are at an important market junction, I like to wargame a few scenarios:…” would be laughable if it weren’t so sad.

    Enjoy it while it lasts.


    BR: I’m going to call bullshit on your comments. No one’s “savings are being destroyed to prop” me up. And if you paid attention to what has been discussed here, you would have avoided the crash in 2008 and participated in the upside as well.


  22. Conan says:

    I think it is import to remember that the market is to make money. There needs to be rules and regulations against fraud, but bottom line it is to make money, not social policy. Further more it is a rough and tumble place to be, it is not for the innocent or unaware. If you place your money there, hold onto your hat as there are no care givers or cutodians to watch over you. I don’t care what anyone says, no one is out for your interests. So be prepared if you choose to enter this realm and yes it is a choice, no one has a gun to your head.

    It makes no difference if you invest for yourself, hire an advisor our use a 401 K, it’s your money. Even for the best prepared it is a tough business to consistantly make money and mitigate the losses. So be real and deal with the market the way it is, not as you wish it to be. That is the biggest mind game that is out there in my opinion.

  23. Molesworth says:

    Used to follow ECRI like a religion. Now they may be caught in their own cognitive bias. Their WLI keeps going up but they say we’re in for recession.
    My own long term MACD charts are flashing green again.
    ECRI says duck. Technical charts (or voodoo as some claim) say buy.

    What am I doing:
    1) I’m cowering until we’re a couple weeks into earnings to see which which is which.
    2) Going to re-read Thinking Fast and Slow.
    3) Read TBP, Kiron Sarkar, Calc Risk, check FinViz news feeds for headlines that interest, do a crossword puzzle, meditate.

    Q: Is The Bernanke more powerful than the business cycle?

  24. ZedLoch says:

    “Sometimes its painful to fight my way through them”

    I know! I am always looking for contrary information, because I don’t want to get caught with my pants down. I have a few friends who always have something intelligent to bring to the table: some aspect I missed, or didn’t put enough weight on to. They back it up with facts, charts, statistics and figures. I love it.

    Too many other’s make asinine comments that take a 5 second google search to disprove. I too often find myself wasting time on this kind of rubbish.

    So if you can find someone you respect on the “other side”, stick to em like flies on poop and the two of you will go far ;)

  25. My Benchmark: The moment I think I can explain why a market moved the way it did, or I start to make analyses that forecasts where things will go…I’ve got inherent bias.

  26. Arequipa01 says:

    “this is a good place to go long with a stop around 137o on the S&P.”

    S&P 500 hit 1371 @ 11:41 am. Looks like you got your wish.

    I like the fact that Mr. Ritholtz is advocating ‘abductive reasoning’ as well as inductive and deductive. One must ‘speculate’, ponder, intuit on occasion.

    “but it is tough discerning reality”- what wonderful comment- no sarcasm intended at all. “What am I seeing?” is a fundamental question.


    BR: I intuit that 1330 looks like support on the SPX!

  27. obsvr-1 says:

    watch the crowd, participate by investing riding the wave of the “crowd slope” and then watch very carefully for the greedy, greedy (I’m ALL IN) or the worried capitulators (The SKY IS FALLING) to transition to ” watch the crowd and do the opposite”.

  28. Irwin Fletcher says:

    Wow, what a good post of honesty.
    It is sooo difficult. What I find is that once you have your money on the table,
    your nature is to “take a side” and root for the desired outcome, and look for others
    to confirm your “hopes”.
    BR, for you to actively look for opinions contrary to your own is why you are good at
    what you do, and why I read your blog.

  29. Bill Wilson says:


    The market had the decency to put me out of my misery quickly this morning. Looking back, I think I did two things wrong. First, I tried to catch a falling knife. I should have waited for a bounce before buying. Second, I ignored the DAX which got killed today. I think the DAX has been leading the S&P lately.

    If the DAX can bounce off of 6600 tomorrow, and the S&P can recapture the 50 day moving average, this still could be a decent buying opportunity.

  30. [...] Extended markets don’t have to “crash.” Sometimes they consolidate.   (Big Picture) [...]

  31. wally says:

    “What are you doing about your own inherent biases?”

    Indulging them.

  32. Arequipa01 says:

    @Bill Wilson

    Interesting. Thank you for responding. So there isn’t any lingering doubt, my comment was neutral, in that it was a reaction to the suddenness of the move.

    Also, thank you for your notions regarding the DAX. Do you have any reason to believe that the DAX will be able to bounce off of 6600?

  33. bear_in_mind says:

    I’m eagerly watching and trying to make informed decisions when to add (and reduce) positions. On the shorter-term, I have to wonder if we’re not seeing a confluence of consolidation activity combined with “Sell in May” itchiness, QE quesiness (will it stay or will it go?), and MENA / Euro skittishness. I’ve taken some profits on long positions and will wait for further trend developments to unfold. If this snaps right back to the upward trend, I’ll take that into consideration. Otherwise, taking a pause to look for late-Summer entries in advance of the Fall-Winter ramp-up that typically carries the market through the holidays… not to mention the elections.

  34. dead hobo says:

    BR opined:

    I intuit that 1330 looks like support on the SPX!

    You’re the pessimist. I’m the optimist. I’m thinking 1350ish. You’re probably right since that level real quick would be a scare and a half. This leaves 2 questions …

    1) Sideways for an annoying time or quick rebound to 1400ish, then a very very gentle slop upwards to about 1440 before another plop?

    2) Europe???

    HFT ‘knows’ that 1400ish is a good level to strive for and beyond is possible if earnings are OK. The new dynamics are fast drops and slow rises, several times a year. The US economy is growing. Population growth will make sure China grows economically. Commodity thieves are finally learning that the consumer can adjust demand over the long run, making their sure bet on long commodity funds a little pale, almost dead money. This should make the world a little more affordable over time. I truly love the quick buck, but don’t doubt the future. Feel oddly serene.

  35. Bill Wilson says:


    I have no fundamental reason to believe the DAX will hold at 6600. On the daily chart, the March low of 6600 stands out to me as a position of strong support. But, today I thought the 50 day moving average would offer strong support to the S&P, and the market blew through it like a hot knife through butter.

    The headline risk out of Europe is crazy. Today, Europe sold off because of Spanish bond yields. I imagine the next leg up in Europe will be fueled by a bailout rumor. But I really don’t know.

    If the DAX can bounce off of 6600, that will be a signal to me that the market is ready to head up for a few weeks. I can’t justify why the DAX should move up. It makes sense to that investors in U.S. equities are taking clues from Europe. A recession in Europe will most likely effect the U.S.

  36. lalaland says:

    I’m all cash on the sidelines until the 10 year stays above $2.25 for 3 weeks straight, although I might make that a month if I’m not convinced, but I’m probably playing a different game than y’all

  37. AHodge says:

    the easiest way to change wrong beliefs or opinions
    is not to have ANY beliefs or opinions– just conditional hypotheses
    and think though ahead of time the level of refutation you need.
    just say you have a few ideas and you see if they might work.
    you can also have too little conviction and get stopped and pushed by every market move

  38. darth beta says:

    How does one know what is contrary if they are subject to biases?
    Socratic thinking includes alternative and opposite viewpoints but how does one know what is alternative or opposite?
    If I typically date tall women would the alternative be short women? Or is it to ignore physical features altogether and date funny woman? Or does one date men?
    I find interesting that the common opinion to bull market is bear market.
    Is the opposite of investing, not investing, spending, charity or something else completely?

  39. 4whatitsworth says:

    Let’s be honest no one really knows how this stuff really works we get some of the basics right but that is about it. For me averaging in and averaging out is the best way I have found to eliminate the emotional response knee jerk thing. In this case I was about 20% out and boom. Not sure if it’s a crash or a correction my bet is that it is a correction and it may or may not continue. At this point I will sit tight and watch earnings, Europe and the Middle East and go from there.

  40. carleric says:

    I plead guilty to strong biases…not to brag (much) but I made so much money shorting tech beginning in 2000 that to this a day I can’t belly up to the bar and buy tech comfortably. I am exactly the opposite way with oil and gas enterprises ……doing really well post Katrina in the natural gas world. The way I deal with it is I buy what I know and understand and don’t buy what I don’t understand or like. It works for me but readily admit I always bring some pretty strong opinions to the table and readily admit caution is advised in any investing I do. The only concession I make is that as I grow older I become ever more cautious.

  41. techy says:

    4whatitsworth .. I second that.

    to understand h0w clueless that market is about the future you just need to look at the option market.

    you can make money by betting below 50% of current price and betting above 60-70% of current price (say AAPL). That exists for a reason, stock markets are not based on true value, its a place to speculate.

  42. parsec says:

    I’m a permabear by nature but Barry’s excellent analyses and graphs have convinced me in recent years to do outrageous things like switching half my 403b into equities in early October. My usual favorite is to watch for a lot of talk about how the long bond “bubble” is about to pop before switching into them and the zero coupons. But that’s for a different environment. This looks more like a catch-your-breath stop along the way.

  43. [...] Consolidation vs. Crash (The Big Picture) [...]

  44. drctypea says:

    how would you define the conditions in a market crash if what you describe above are the conditions for a consolidation?

  45. [...] mentioned previously, to avoid confirmation bias, I force myself to read some folks whom I disagree with. When Doug Kass [...]

  46. [...] Consolidation versus Crash (April 10th, 2012) PERMALINK Category: Markets, Psychology/Sentiment, Technical [...]