The Biggest Question Traders Face

There are few traders who do not at least acknowledge the high levels of sentiment we are seeing right now. The question is, does it matter? When you plot the long-term movement of the major indices, they can begin to appear like the side of a mountain. A multi-year chart will show you peaks and valleys as traders take prices higher and then sell as a sense of fear rushes over them. Like most mountain tops, it doesn’t come to a sharp point, but in many cases is more jagged and at certain points it even flattens out.

Those that have taken on the tallest mountains in the world like Everest, K2, and Kangchenjunga would likely tell you that each mountain has its own unique challenges and pose different dangers. What you would pack and even how you train is greatly influenced by what you are about to climb. Mount Wycheproof in Australia is the smallest mountain in the world, standing at just 141 feet tall. Mt. Everest is over 200 times taller than Wycheproof, and takes a much more seasoned climber to master it

The biggest question traders face, and are unable to clearly answer at this point, is how big of a mountain are we climbing?

One of the most often mentioned pieces of data that traders are worried about has been the high level of margin debt. We’ve exceeded the 2000 high and are approaching the 2007 peak. Some will argue that as a percentage of GDP we have not hit previous highs and the rate of increase in margin debt has also not been as strong as previous years. Is Margin debt high? Sure. Is it too high? No idea.

In 1997 margin debt had more than doubled from 1994 levels and was three times higher by 1999. In ’97 it wouldn’t have been hard for an investor to say that things looked excessive and called for a market top. However, the S&P 500 ($SPX) doubled from 1997 to the 2000 high. Equity bulls weren’t finished climbing in ’97 and the summit was still three years away.

The same could be said for the inflows into equity mutual funds. Are inflows at historically high levels? Yes. In fact as the chart from BaML below shows, we have recently seen the highest level since March of 2000. Look at the spike in inflows back in 1997, we saw a high level of retail investor exuberance back then, but stocks continued to head higher.

It turned out that the tech bubble was more of a Mount Everest than Mt. Cho Oyu or Mt. Makalu. I’m not here today to say that things don’t appear off-kilter towards high levels of investor enthusiasm. The point I’m attempting to make is that the scope of the move is extremely important.

Trading is a journey. We will see highs and lows and eventually a peak will be reached. Unlike those that climb tall mountains, we do not have a map to the top. We are climbing blindfold, only given a few more inches of rope each day that leads us to the summit. If we chose to stop climbing here then we could potentially miss the beautiful view from the top. However, as we do continue to climb, the trek does become more dangerous and caution and risk management are always important tools we must take with us on the journey. So are we near the top? I have no idea. Things sure do look like other mountain peaks, but the climb we are making is unique in and of itself.

Happy climbing.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.