Analytics: The greater fool theory and weak closes

Here is a definition I love, and everyone who trades the markets should know:

Greater fool theory:  A theory that it is possible to make money by buying securities, whether overvalued or not, and later selling them at a profit because there will always be someone (a bigger fool) who is willing to pay the higher price. Courtesy of Investopedia.com

With the greatest of fools in mind, consider the implications for the tail end of a bull market.  As stocks become overvalued and no longer wise purchasers, the only buyers become those with the least knowledge, information or experience (the greatest of fools).

If you can tell that the only ups in a market are coming from the fools, you know it’s time to trade places with one of them.

How do you do this you ask?

Time is probably the simplest answer.  There is an old market adage that says something to the effect that “Novices control the opening; professionals control the close.” There is a logic to this statement: the amateur traders only devote the time before or after their day job to placing trades and doing research (usually). This means that they place their trades in the morning before they leave for work, or in the afternoon after the markets close.

If you notice the last couple of weeks, stocks have opened high and closed lower, ending the day in the red.  This tells me that the professionals are selling into the “greater fools.” The trend has been happening almost every day: strong start, painful finish.

The crux of the situation is that people will only keep buying for so long and then all the buyers will fall out. Keep in mind what the market is seemingly telling us. If this isn’t just noise, it may be time to let the “fools” take over and side with the pros.