By Rob Curran
Of DOW JONES NEWSWIRES 20 March 2009
NEW YORK (Dow Jones)--The sudden spikes in stocks such as Citigroup Inc. (C) and American International Group Inc. (AIG) suggest that trader psychology is still a more powerful influence than fundamental analysis on this stock market.
The shock of Lehman Brothers Holdings' failure last September and the subsequent market plunge caused losses that had a traumatic effect on traders and investors. A sustained level of volatility not seen since the 1930s may be a side effect of that trauma.
Losses curb a trader's ability to make rational decisions, leading to erratic buying and selling, according to money managers and a psychiatrist who worked for a major hedge fund. The most destabilizing situation for a trader to be in, they say, is a short position - which is essentially a bet that a stock price will decline - that suddenly turns against them.
Bailing out of those bets can cause spikes such as the quadrupling of Citigroup's stock from 97 cents to its high of $3.89 in the last two weeks; or AIG's move from a low of 33 cents to as much as $2 in less than a week. The stocks jumped even though there wasn't a fundamental improvement in the outlook for the troubled companies.
Losses "lead to trouble making decisions, trouble staying with a strategy; they lead to a lack of confidence and demoralization," says Dr. Ari Kiev, a psychiatrist who recently finished a 16-year stint as the in-house trading coach for Steven Cohen's hedge fund SAC Capital.
"It's not officially post-traumatic stress disorder, but it has some of the same characteristics in the sense of not wanting to face the situation again, [and constantly] thinking about it. People get sick to their stomach and feel like throwing up."
Kiev, who now coaches money managers in his independent practice, said he often counseled traders at SAC who were mentally unsettled and even feeling nauseous because of trades that went against them. Prior to his stint at SAC, he helped Olympic athletes with mental preparation.
In his work, Kiev has noticed that trauma was more common after a losing "short" bet.
Short-selling is tougher on the mind for several reasons. If a trader borrowed and sold Citi stock for $1 apiece - and, according to one Wall Streeter, some traders did so, albeit as part of a hedging strategy - the most he could gain is $1 a share. That would be the case if the stock went to zero and the trader never had to replace it. When the stock hit $3.89 Thursday, the trader was down by $2.89 a share, more than double the original stake.
In theory, losses are unlimited when a stock is sold short. Plus, stocks that are popular with short sellers are prone to "short-covering bounces" or "short squeezes." These happen when people notice a sharp move upward and rush to buy back their bet. In the stampede that follows, stocks can gain value exponentially with the slightest fundamental provocation. Some say that's the case with Citi, AIG and other financial stocks.
When a trade goes bad, the trader often feels compelled to double down again and again, says Lorenzo Di Mattia, manager of hedge fund Sibilla Global Fund. Even a successful trader using stop losses can fall into this trap, Di Mattia said, and he is constantly on guard against what he calls the "snowball effect."
Quincy Krosby, chief investment strategist for Hartford Financial Services, says traders have experienced their own crisis of confidence in recent months, as losses cause them to "question their judgment."
Psychological healing - and thus reduction of volatility - will likely take a while.
-By Rob Curran, Dow Jones Newswires; 201-938-5176; robert.curran@dowjones.com [ 03-20-09 1130ET
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