Optimism and confidence are the cornerstones to success in the business world. The same attributes, however – optimism and (over) confidence – are the biggest stumbling blocks to success in the investment world.

Allow me to share a little anecdote to illustrate this point. A fully grown stag (a male deer) is sipping water at a lake when he looks at the reflection of his fully developed antlers. “Oh if only my legs were as beautiful as my antlers” he ponders. At that very moment an arrow zips into the lake, missing the deer which it was destined for, by just a few inches. Yet, the very legs the stag was complaining about brought him to safety.

Just a little while later, the stag got enthralled with his antlers once again. In fact, he got so caught up admiring his crown of beauty that he didn’t realize he’d been wondering into the thicket. The harder he tried to unhook his antlers from the shrubs and bushes, the more he got stuck. It wasn’t long before the hunters found him. This time, the arrow did not miss its mark. What the stag perceived to be his strength actually became his weakness.

The moral of the story; don’t become so overconfident in perceived strength’s that you lose sight of your surroundings, it might be very dangerous.

The curious case of the confident loser

To properly understand why confidence, or optimism, are detrimental for investors, those attributes have to be analyzed in the context of how they develop.

A Barclays Capital survey of 820 hedge funds, asset managers and traders from institutions across Europe, Asia and the U.S. showed that more than half of the respondents felt the recent rally is sustainable. When asked in June, the majority of respondents thought that the bounce from the March lows was only a short-term correction on the market’s journey to lower prices.

As the chart below shows, the confidence in rising prices increases along with rising prices. The S&P 500 (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC) rallied over 50%, while bullish advisors “rallied” from 26% to 51%. Eventually, elevated confidence readings become a trap for investors (more about that in a moment).

Unlike Wall Street and its advisors that were caught up by the doomsday atmosphere surrounding the March lows, the ETF Profit Strategy Newsletter actually recommended to buy when everyone else wanted to sell.

ETFs recommended via the March 2nd Trend Change Alert includes plain vanilla broad market ETFs like the S&P 500 SPDRs (NYSEArca: SPY), Dow Jones Diamond (NYSEArca: DIA), Nasdaq (Nasdaq: QQQQ) and Russell 2000 (NYSEArca: IWM), sector ETFs like the Financial Select Sector SPDRs (NYSEArca: XLF) and Consumer Discretionary Select Sector SPDRs (NYSEArca: XLY), along with leveraged ETFs such as the Ultra Financial ProShares (NYSEArca: UYG) and Ultra S&P 500 ProShares (NYSEArca: SSO). Those ETFs rallied much faster than the trailing optimism.

Overconfidence becomes a problem for the bulls as a run for stocks increases the base of stock owners. At a market top, people wanting to own stocks will have converted from wanna-be buyers to owners. At that point, the pipeline of new buyers has dried up to a point where there's not enough buying volume to drive up prices any further.

This is compounded by the fact that owners are reduced to either holding or selling, neither of which can propel prices. As the base of stock owners has become un-proportionately high, the cycle reverses. Inevitably, some owners give in and start selling. As prices start to decline, more stocks are being sold and selling becomes the new trend. The unusually high level of stock ownership provides a consistent flow of stocks being put up for sale, resulting in rapidly declining prices.

No reason for confidence

New bull markets climb a wall of worry, they don’t ascent an escalator of hope. So an elevated level of investor optimism is never a good sign. It is, however, especially treacherous if there is little to no fundamental reason – aside from rising prices – to be optimistic.

What should worry the proponents of a continued economic recovery is the discrepancy between fact and fiction. If, in fact, the economy is improving, so should production and trading activity, right?

In the good old days, Charles Dow – the founder of the Wall Street Journal and creator of the Dow Jones Averages – would recognize a new bull market by increased production and increased shipping/distribution activity. His reasoning was as follows:

Industrial companies manufactured the goods and the rails distributed them. Since both sectors were co-dependent, both sectors had to move in the same direction to validate a trend. If one went to a new high while the other one lagged, there was a bearish divergence.

Today’s shipping activity can be measured by the Baltic Dry Index (BDI). The BDI tracks worldwide international shipping prices of various dry bulk cargoes. As such, the BDI is a reliable measure of world trade and economic expansion. In fact, movements in the BDI often foreshadow stock market movements.

It should be a concern to any investor that, simultaneous to the rally in stocks, the BDI has dropped from above 4,000 to below 2,000, within less than four months. In 2007 and even 2008, the BDI reached tops between 11,000 and 12,000. This means that shipping/distribution activity has contracted by nearly 85%.

Ghost ships to haunt Wall Street

A collapse in shipping charges is the result of slumping demand. A year ago, it cost $1,400 to ship a 40 ft steel container full of merchandise from China to the UK, today it’s a mere $300. Today, an entire 100,000 ton bulk freighter can be chartered for $10,000 plus fuel charges; a year ago it was $300,000.

MailOnline reports that there are some 500 high seas freighters anchored east of Singapore. This is a maritime fleet bigger than the U.S. and British navies combined. The ships have no cargo, no crew and no destination. With Christmas shipping in full swing, this is usually the busiest season for ship operators. This year, however, there are no orders.

If there was an economic recovery, at least some of those ghost ships would be setting sail to deliver goods across the big pond. But that is not so. In fact, every week a few more ships lay anchor. Every anchored ship reflects dozens, perhaps hundreds of lost jobs, and step by step brings Wall Street closer to the perfect storm.

Ignorance is bliss

Every one is a genius in a bull market. Everyone is a genius in the first stages of a bear market rally. Up to the point of recognition, bull markets and bear market rallies look the same to most. But how can you distinguish a bull market from a bear market rally?

The last bear market rally, comparable in scope to this rally, fooled investors from November 1929 to April 1930. During that period of time, the Dow gained nearly 50%. The March 25, 1930 issue of the New York Times reported the following: “Wall Street was in a cheerful frame of mind as a result of numerous vague reports of improvement in business and industry.”

Today, Wall Street’s cheerful frame of mind can also be attributed to vague reports of improvement. Yes, some indicators with an awful record of predicting economic cycles have turned positive, but the meat and potato indicators investors usually can bank on, are still raising red flags.

The ETF Profit Strategy Newsletter, the newsletter that predicted a 2008 Dow bottom below 7,500 and 2009 Dow bottom below 6,700, provides a weekly market analysis with ETF profit strategies based on a comprehensive study of indicators that work, not emotions. Perhaps this type of analysis will prevent your portfolio from getting stuck in the thicket of optimism. Take a lesson from the over confident stag.