Bottom-Calling Is a Fool's Game

The more unpredictable the world is, the more we rely on predictions.
-- Steve Rivkin

Although crude oil prices are down, overseas markets were very weak and the U.S. market is off to another rocky start. Worries continue to grow over problems in the financial sectors and a sputtering worldwide economy. Confidence in the market is extremely low, and when we do get some sort of bounce, many investors are using it as an opportunity to exit.

The problem here isn't a complicated one. The market discounts the future, and many are now coming to the realization that we may have underestimated the extent of the issues in the financial sectors. There has never been great clarity over the extent of the problems faced by banks and brokers, and then when we hear about the extend of off-balance-sheet issues at Fannie Mae (FNM - commentary - Cramer's Take) and Freddie Mac (FRE - commentary - Cramer's Take), market players start to realize that we really don't know what the truth is when it comes to the financial sector.

The great difficulty of this market right now is that we are obviously in a very ugly downtrend but oversold enough that many are looking for a bounce. We aren't getting quite enough panic or fear, so we end up with a series of feeble rallies that quickly fade. We are seeing a particularly good example this morning, as a spike in the last hour yesterday is being undone by a weak open this morning.

There are a number of ways to approach this market, but the key thing is to be very respectful of the fact that the major trend is down. That is not going to change if we he have a bounce and a few days of positive action. It is going to take a series of positive days to change the trend, and the most dangerous thing you can do is to anticipate that action.

Unfortunately there isn't much else for market pundits to focus on other than the chances of some sort of bounce. Wall Street is like Pavlov's dog when it comes to calling bottoms. As soon as there is a downtrend, the reflexive action is to proclaim that we have a great buying opportunity and that a bottom is at hand. The vast majority of the time, those predications are dead wrong, but that doesn't stop the pundits from making them. Unlike real investors managing their own money, there isn't any cost to constantly making incorrect predictions, so they just keep on doing it until they finally can proclaim they were right.

Make sure you keep the right perspective about the bottom-calling game. It is not going to disappear, and it can be very hard to resist. As long as you are aggressive and respect the fact that the overall trend is down, you can play the short-term bounce game and keep losses contained if your timing is off. The easy way to get in trouble is to start believing the pundits that it's time to buy for the longer term before the market provides some evidence to confirm that.

No positions.

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James "Rev Shark" DePorre is the author of Invest Like a Shark: How a Deaf Guy with No Job and Limited Capital made a Fortune Investing in the Stock Market. He is founder and CEO of Shark Asset Management, an investment management firm, and he also operates sharkinvesting.com, an interactive online community that serves and educates active investors. DePorre holds business and law degrees from the University of Michigan, is a member of the Michigan Bar Association and a former tax attorney and CPA. He lives in Anna Maria Island, Fla., with his wife and two children. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Rev Shark appreciates your feedback; click here.