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Does pessimism make for a safer market?

We are trained to believe that as investors we want to be in an environment of extreme market optimism. On the surface, this sounds reasonable. When people are optimistic, money flows into the market and stocks head higher. It seems like an ideal situation.

But is it really? The argument can be made that an overly cautious market can be more favorable, because it limits the downside potential of major moves.

This idea has been named  “The Freudian Put” by Phil Pearlman, the executive editor of StockTwits. In a recent interview, he explained his concept of The Freudian Put, and discusses why it can be a good thing for investors.

His thought is that over the last 10 to 15 years the market has been riddled with bad news, and he is right. The dot-com bubble, Iraq War, housing and auto crisis, debt ceiling… the list goes on and on. We have basically been conditioned to expect bad news.

Now you will ask yourself, how is this good for investors?

The idea is that we are so conditioned to bad news, that when it happens people react much quicker. On a day with bad news, the headlines are flooded with doomsday reports about the upcoming crash, or how it is time to jump out of the market and wait on the sidelines.

As any experienced investor knows, these are the sorts of the headlines that you typically see at the end of a selloff, not at the beginning. When everyone is talking about running for the hills, the smart money steps in and looks for bargains.

Michael Fowlkes

Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va.