Friday, 27 November 2009
*** Attention Bulls ***
*** Attention Bears ***
It should be obvious by now that the market will often behave independently of what the current market forces and economic conditions are. This can leave one at a loss for how to engage such a market rationally while still limiting the level of risk.
On the Bullish side:
Many of those who have subscribed to “buy and hold” have been burned badly as the market plummeted. Parts of the market has bounced back from the March lows, but other segments are still languishing.
On the Bearish side:
Many shorting or expecting the market to collapse have been stymied by the continued run up from the March lows with no sign of weakening. Anyone attempting to short this market has most likely been in a losing campaign.
In both the bullish and bearish scenario’s listening to the news would not have helped you make sound decisions in the short term as there has been a mix of both positive and negative information, and not only that, the market seems to ignore the information most of the time.
In my research, I’ve found that the best way to invest in this market is to accept that fact that the market is bipolar, meaning its normal state isn’t rational- either everything is great, or everything is rotten.
The next step is read the current financial data and make your own projections where the market “should” be going. You’ll have to determine this yourself as the news always presents conflicting information and will only confuse you if you don’t have a good grasp of the current state of the economy. This will tell you where the market is headed eventually- and here, the key word is EVENTUALLY- it could take some time for this to happen so consider it an “extended forecast”.
The last step is to understand “Trend Line Analysis” and “Support and Resistance” areas specifically as well as the art of technical analysis in general. You will need to know this area in order to determine when to buy or sell.
So putting it together, we have three main components to achieve success:
1) Accept the market is irrational (Bipolar)
2) Determine the “extended forecast” of the market.
3) Know Trend line and Technical Analysis
This is how you put them together for more successful investing experiences:
Knowing the “extended forecast” of where you think the market is headed will be invaluable for your long term (at least 1 year or more) investments. It will provide you with an early alert on whether you should be adding to your position or reducing it and moving it somewhere else. If done right, you should be able to avoid being caught in major market crashes as well as keeping your assets in stronger investments.
For short term trading/investing, knowing where the market is headed with your financial extended forecast information won’t be as helpful due to the bipolar nature of the market. The market has the uncanny ability to keep moving in one direction regardless of the current financial conditions. There is also an abundance of automatic computer trading going on which makes decisions on other things besides current news. The media, looking to explain any market movement with current news only adds to the confusion and you wind up with ridiculous “can’t lose” scenarios. Here’s one example:
The national unemployment numbers for October went up to 10.2%, which was higher than expected, but the market was seemingly unaffected and rallied. The financial news media stated that the market rallied because that higher unemployment number means interest rates will remain low. This makes no sense as the negative of a higher unemployment rate is of a higher magnitude that the positive of lower interest rates. Now on the other hand, had the unemployment number been lower than expected, the market would have rallied and the media would have proclaimed that it was due to signs that the recovery was taking hold, ignoring the interest rate angle altogether. Therefore no negative scenarios exist in this case that would result in a negative market move. This makes no sense in a rational market, but behaves as expected in a bi-polar market.
The way around this situation in the short term is to focus primarily on technical analysis (TA) instead of the news. If TA dictates the trend is up, go long. If TA points down, go short. In each case include a protective stop loss trigger as a risk limiter. This technique should keep you on the right side of trades in the short term while you’re waiting for your long term forecast to come to pass.