Risk Ladder

There is something known as a "risk ladder" that when "risk is on" you will see "climbed". In other words, investors seek risk when they expect monetary and credit expansion and when they foresee capital outflows from bonds and cash and think it will seek some sort of return. Then they may "go down" the risk ladder or move towards "risk off" when they seek protection of capital and have faith that bonds will hold the principal. You see this in more subtle ways on a short term time horizon that sometimes provides clues as to where we go next, but the longer term allocation money always will override the shorter term shifts.

The view shown in the bottom left corner of the picture may provide actionable information on the long term time horizon because it eliminates the noise but the picture above doesn't completely tell the whole story. For risk exists in far more ways than just asset wide, but it exists WITHIN an asset class, sector, and even industry between individual stocks which allows the more subtle movements and complex rotations that can be recognized, and there are cycles of sentiment that exists within individual divisions of an individual company and earnings within individual companies and then the greater and greater collective earnings picture as well as capital flow cycles and rotations.

There are various elements that may be considered a greater "risk". There is risk of the underlying company, there are risk of movement of the stock price, risk of changes in dividends. There are risk of accounting fraud, changing in management,FDA approval/denial, etc. There are risks from chasing a stock of an eventual pullback, or buying a dip that your position will continue it's direction so that you may capitulate before it turns around and goes higher... But I think the risk most overlooked by the average joe are how liquidity concerns and risks influence decisions by the professional large institutional money manager.

On the short term, you have risks of institutional clients who can still move markets, but the pension funds, the soverign wealth funds and the international and extremely large institutions and investment banks and companies and mutual fund managers of varying sizes make up the larger trend at work that also triggers collective action of the shorter term motions. Thus a panic is like a school of fish, trigger just a few leaders and they all start moving as one without knowing why they just react.  You have to learn about all individual components within the stocks so when you begin to see early signs of panic you can move ahead of the MAJORITY even if you are a little bit late, and at times you have to anticipate the move even though you will occasionally be a lone fish and be wrong and have to join the school for awhile yet again.

It is one thing to understand cycles, it is another to understand the "optimal strategy" to capitalize off of rotation or more specific cycles to handicap and exploit individual cycles... and how and when to deviate from that "optimal strategy", but that is another story. For now just understand that certain instruments represent risks and try to see the ebb and flow between them as indicators on varying time frames. Also learn how to understand volume profiles and how crowd psychology can be anticipated based on varying degrees of aversion to pain and tendency to defend price points and where the crowd will generally begin to experience "pain". When it comes to pain everyone has different thresholds before they can't handle it anymore and move on, but there is  tipping point in which a highly likely domino effect takes place and one sale leads to lower prices as there aren't as many buyers from below with the psychology to rush into buy relative to the number of sellers above which creates fast movement of prices. Combine that with the knowledge of the ebb and flow and the signs provided by instruments on varying levels with varying degrees of importance and you should be able to handicap the market more accurately through intelligent objective analysis.