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April 30, 2004

No Rhyme or Reason?

By Kathryn M. Welling

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If you think the market needs a shrink, call Woody Dorsey. Woody, who publishes "Market Semiotics" weekly from remote Castleton, Vermont, and who's new book, "Behavioral Trading," was published a few months back by Texere, has been analyzing the recalcitrant beast for years, by paying close attention to what the discoveries in the field of cognitive science say about the way the folks who make markets really make decisions. It's fascinating. - KMW

Have we had your "March Massacre" now, Woody?

You can certainly say that we've had a nice massacre. This really qualifies as an abrupt and sharp price decline. It may bounce around here a little bit, but it's not ready to go back up. We can have another ride up until May - after this is all over. Basically we're in transition from a one-way miracle market to a more typical two-way market.

That has a nice ring to it in terms of a return to some normalcy.

The reality is the market is a voting operation; it has a lot of different characteristics. It surprises even those who expect surprises. But going into a two-way market, after going through this honeymoon for a year, is perfectly reasonable. What I am talking about is that the markets were so extended and when you break down out of that extended kind of optimism and complacency, nobody's going to be too quick to jump back in. Everybody worries that the corrective process can always take a few more prisoners. One of the ways that happens is that the market puts in a bottom like - maybe - it did one recent afternoon and they try to rally it for a couple, three days. In that process, they see what it's made of. What they look for is for the market to pull back again and make new lows or retest the lows. So there is a digestion period - and it makes sense to wait it out. What's more, this market break is not really very old in terms of time.

Your book, "Behavioral Trading," [Texere/Thompson, 2003] has finally been published since we last did an interview. Are you already working on a sequel?

Well, writing forces you to think. Yes, there are always nuances and things that come to you after you put the pen down, so to speak. I see "Behavioral Trading" as a breakthrough.

Isn't what you've tried to set out something of a riddle wrapped in an enigma? A way to analyze how frequently irrational humans behave in markets - why we do what we do.

Behavioral finance is really about humanism, so you really can't quite compare it. It is an entirely new way to approach the markets, not a comparative way of looking at things. As you observed, it's really about the human psyche or the human mind. And although we can send a man to the moon and we can listen to cell phones in remote caves and we can do wonderful surgery, nobody knows where the S&P futures are going to close on Friday.

Yet lots of investors are willing to make bets.