3 Reasons Bulls Take On Too Much Risk [Tesla Motors Inc(NASDAQ:TSLA), Facebook Inc(NASDAQ:FB)]

Wall streetDavid Fabian:  A few weeks ago I wrote an editorial on the three reasons that bears never prosper.    The thesis behind this argument was that a one-sided view of the market can be dangerous to your wealth, especially when coupled with a lack of investment discipline.  In response to some of the feedback that was generated from that piece, I felt it was a prudent idea to look at the other side of the coin and analyze the short comings of bullish investors as well.

If you ever need a dose of bullish optimism in your day, you can always turn on CNBC which has a never ending parade of sunshine and lollipops for investors.  Whether it is secret value opportunities or hot momentum stocks, they are all strategically designed to get your dollars flowing in one direction.  These bulls don’t often offer up any words of caution, but are instead pounding the table to get you to put money to work in the market regardless of the timing or your unique situation.

1. The News Is Always Best At The Top

With the SPDR S&P 500 ETF (NYSEARCA:SPY) hitting new all-time highs this week, the enthusiasm for risk taking has never been higher.  News stories about momentum stocks like Tesla Motors (NASDAQ:TSLA) breaking above $200 and Facebook (NASDAQ:FB) acquiring messaging service WhatsApp for $19 billion are continuing to stoke the flames of technological innovation and corporate strength in the marketplace.

These feel good stories spark a rising tide of equity prices that lifts all boats in the harbor.  However, it is precisely these moments of excess that often lead to swift corrections or changes in market tenor that can catch the bulls off guard.  News is often times the most bullish at market tops and most bearish at market bottoms.  After all, if everyone is bullish and invested in the market, who is left to push it higher?

The psychological nature of the markets makes this a counterintuitive indicator, however it should give you pause to put new money to work when all seems rosy.

2. Markets Take The Stairs Up And The Elevator Down

One of the things that is hardest to remember at the top of the market is how easily gains can be wiped out.  Stocks can grind higher for weeks and months at a time and then suddenly have the rug pulled out from under them when you least expect it.  A quick look back at the summer of 2011 can shed some context on this phenomenon, as SPY lost 16.58% of its value (on a closing basis) in just 12 trading sessions.

Aggressive investors or those with long-term time horizons can often times handle that kind of volatility and are suited to make up the losses through time or trading strategies.  However, those that are in retirement or don’t have the stomach for large price fluctuations should be mindful of the downside risk.

By my count, SPY has now been above its 200-day moving average for 15 consecutive months now.  Everyone is a bull when the markets are rising for long periods of time and the gains come easy.  However, your resilience will be tested when volatility returns with a vengeance.

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