When the Herd Turns
Once market participants realize the top is in and the only possible result from here on is a loss, the herd will turn and follow the leaders who are selling.
A funny thing happens when the stock market herd turns–all the usual central bank tricks no longer push the markets higher.
Though the mainstream financial media reports on central bank policy as if the policies move the markets, the actual mechanism is not policies per se but their effect on the belief structure of market participants.
If market participants believe the markets are going higher, for whatever reason, they will buy more stocks to reap the anticipated gains.
If market participants believe the top is in and markets will decline, they will sell, i.e. liquidate positions rather than build them. This is called distribution, as the smart money distributes stocks to the greater fools who have yet to get the memo that the top is in and from now on, stocks will only lose value.
When the leaders of the stock rally dwindle to a few names, that is evidence that the herd is losing its momentum and confidence.What causes the herd to turn? The process is not entirely mechanical or predictable. Those in the front of the herd tend to lead those following, and so we look to the leading stocks, sectors and players for clues as to what the herd will do.
When those leaders no longer make new highs but instead notch lower highs despitegood news, that is further evidence that the herd’s direction is becoming increasingly uncertain.
When the herd’s leading edge veers first one way and then the other, this lack of coherence is also evidence that the herd’s leaders are no longer confident in which direction to take.
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