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Dorn: Beware the Market Herd Effect

This is a sloppy jalopy market that is trendless and range bound. It is unable to hold solid gains in the major indices, despite the downage in oil and gold. The seasonals are intact for continued sloppiness into the election and a much-needed correction in oil and gold. Financials are the key to these equity markets, and have seen a nice run off the bottom, just as everyone was proclaiming their imminent death. Once again—the herd is always looking in the same direction. When everyone is looking in the same direction, no one is really looking.

See-sawing with a slight upward bias in equities into the elections serves three purposes: Intermittent positive reinforcement for broad market participants, lessening of fear, and increases in risk-taking behavior.

Intermittent reinforcement breeds complacency and fosters hope---neither of which work well for investors. Most investors will be greedy when they should be fearful and vice-versa. As the cry goes out that “the worst is over for the dollar and there is smooth sailing ahead” people will begin to take the other side of the “ short dollar, long metals” that is now unwinding.

Herding is powerful and contagious. Just as the “short dollar, long commodities” trade became too crowded and has been forced to unwind, the “long dollar, short commodities” bandwagon is picking up steam. This trade is not yet crowded enough, and may need until the end of 2008 to draw the herd into to what will then be the wrong side of an overcrowded trade.

We are seeing what looks like capitulation in the precious metals markets, but bounces will be sold because — contrary to the resounding voices over the past two weeks that “the bottom is in for silver and gold so back up the truck before it's too late!" — it is not. More time is needed to flush out all weak hands in these markets and this could take several more months. Again — there will be bounces that act as intermittent reinforcement, i.e., all is well and the worst is over.

Don’t believe it. The people that are making the most profits in these markets are short-term oriented and nimble. This is a trading market, not a buy, hold and hope market.

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Janice Dorn, M.D., Ph.D., is a financial psychiatrist and chief global risk strategist for Ingenieux Wealth Management in Sydney, Australia. She also offer trading consulting and coaching services via her Web site, TheTradingDoctor.com.

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