Jesse Livermore, once said that the book that influenced him the most was "Extraordinary Popular Delusions and The Madness of Crowds" by Charles MacKay. It might appear odd at first glance, that one of the greatest stock traders in history chose a book about mass psychological hysteria instead of some arcane academic study of economics, but in actuality, this is the perfect book to cite. What Livermore is saying, in no uncertain terms, is that the stock market runs simply on speculation and greed. For every fundamental or technical analyst that picks his or her stocks carefully, there are tens of thousands that are trying to catch the next big winner. People will buy a Certificate of Deposit at their local bank and wait six months to get a fraction of a percent at today's rates; If they purchase a stock however, they will want a double within the hour.
Any market that exists solely on ill conceived logic is destined to be volatile, and a volatile environment is nothing more than backroom card game with a fancy address. There is no difference between Tulipomania in the 1600's and The Internet Bubble of the 1990's. As raw speculators enter the markets, bubbles form in those markets and when they bust, so too does the bankroll that created them. Current volume on the Dow Jones Industrial Average compared to pre-2008 volume is all the proof one needs to conclude that a vast majority of investors are gone and despite the easy flow of money, very few people have as much of it as they did five or six years ago. Any insane and unjustified run where buying enters a maniacal phase is sure to ultimately lead to a destruction of wealth. As Euripides might have said; "Whom the markets would destroy, they first make mad."
Is there another bubble forming? That will be the subject of the next blog entry.
Click the title to read Chapter I of "The Book on Put Option Writing" for free.
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