by Editorial Staff
Updated: March 28, 2015
The following response is excerpted from Prechter's Perspective, a Q&A-style book edited by Peter Kendall that compiles actual trading knowledge from a career that took Bob Prechter three decades to build.
Question: Is it possible that the markets are evolving away from the rule of emotion? At some point, will trading be so highly computerized or so heavily hedged through derivatives trading that emotion will cease to be a significant force in the markets?
[Prechter] No way, ever. First, I expect most derivative stock market products to be outlawed sometime during or shortly following the next major bear market. For emotional reasons, of course. Second, and this also applies to the futures markets, a lot of computer programs have the emotional factors built in. Remember portfolio insurance? Its strategy was to sell more as the market declined, just like people in panic. Those programs participated with gusto in the 1987 crash.
The same idea applies to all trading programs. To the same extent that the world of investors is divided into those who sell rallies and buy declines versus those who buy rallies and sell declines with "stop" strategies, this ratio will persist in the computer programs, which of course are designed by people. Entries and stops will all be triggered at points that the same people would presumably have chosen anyway. Even today, you can often predict "emotional" days by observing times when the market is about to break a 40-week moving average, which many computerized strategies employ as a trigger point. As new programmers try to anticipate such days by triggering action earlier or to scalp in the opposite direction, what will ultimately emerge is the same market action that would have existed otherwise.