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How to profit from the stock market's classic mistake

Arne Alsin, founder and principal of Alsin Capital Management, wrote an interesting article titled "How to profit from the stock market's classic mistake" on Financial Times.

Once again, it highlights the herd instinct of human behaviour, as he wrote "...the precondition to profiting from the market: you have to keep your wits about you...you have to be rational in the midst of irrationality. In a normal market environment, it's easy to do this - the information flow is balanced..."

"At market extremes, though, investors hear a message that is uniformly optimistic (such as during the technology bubble in 1999 and 2000), or pessimistic (such as now). When news, data and commentary are pessimistic...It's difficult to stay cool, calm and rational in a maelstrom of negativity."

"..At significant junctures in market history, psychology coalesces around a single idea or theme. The irony is that it almost always turns out to be true. The problem is that the idea gets overdone. In the late 1990s, it was an optimistic idea: the internet will hange the world. True enough. And, as you know, overdone in the markets."

No one can predict the market direction but the market will always surprise us as Arne pointed out that "...At market troughs, such as in 1974, 1982 and 1990, the market priced in a terrible economy. The market was correct. The economy turned out to be terrible. In each case, though, it was overdone and the market snapped back several months in advance of economic improvement. Investors were caught flat-footed because the rallies were fast and furious. For example, from the trough in 1982, the market rallied 50% in only 90 days..."

Reference:  Financial Times, Arne Alsin, 2008-07-19, “How to profit from the stock market’s classic mistake”