Successfully Navigating Between Point A and Point B

A SIMPLE OBJECTIVE

The basic objective of all investors can be summed up as follows:

We want to make money, and we do not want to lose money.

HOW DO WE MAKE MONEY?

Money is made by holding investments between a point A and a point B when the primary trend is up.

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HOW DO WE LOSE MONEY?

Money is lost by holding investments between a point A and a point B when the primary trend is down. 

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HOW DOES THIS APPLY TO 2018?

As noted in this week's video, based on the data we have in hand today, the primary trend is up, which means our bias should be to hold onto our winning positions until the data says otherwise.  If the primary trend is up, higher highs are coming at some point in the future. 

HOW CAN WE GET OFF TRACK?

The primary causes of most financial market missteps tend to be related to the following:

  1.   Trying to avoid volatility
  2.   Failing to understand what normal volatility looks like
  3.   Making short-term decisions based on fear and emotions
  4.   Failing to clearly define our objectives
  5.   Failing to develop specific strategies and tactics 
  6.   Narrow framing
  7.   Underestimating the psychological aspects of successful investing
  8.   Ignoring/fighting the primary trend
  9.   Making things overly complex

HYPOTHETICAL EXAMPLE - COMMON MISSTEPS

The 1987 plunge serves as an extreme example relative to the 2018 plunge, but we can learn a lot by looking at extremes in the markets.  Let's assume we sold during the plunge or near point A in the chart below. 

If we decided to wait for a breakout or a "clear signal" from the market, we may have reentered the market near point C.  Unfortunately, we would have missed a big move off the low; the gain between point B and C was 16.60%, meaning the entire table shown in this post would have been negatively impacted versus holding from the low. 

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Still referencing the chart above, if we bought at point C, we would have immediately been underwater as stocks fell to point D.  If we tried to add again near point F, once again we would have been on an emotional and financial roller coaster as stocks dropped to point G.  Adding again near point H would have led to another period of emotional capital drawdown as stocks dropped to point I.

SAME PERIOD WITH AN EYE ON THE PRIMARY TREND

Keep in mind 1987 is a much harder example relative to 2018, meaning the evidence supporting the primary trend in 2018 is more broadly dispersed across numerous time frames.  However, there was plenty of "the primary trend is still up" evidence near the lows in 1987.  Therefore, if we held near the lows or added back quickly, we were immediately rewarded with a 16.60% pop off the lows, making it much easier to hold during the multiple-month whipsaw extravaganza that took place between point A and B below.  

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TRADING OFF A LOW CAN BE DIFFICULT AT BEST

The moral of the story is holding between point A and B is a much easier and less taxing exercise versus trying to trade between points A-B-C-D-F-G-H-I-J, and most likely quite a bit more satisfying and profitable as well.

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WHAT HAPPENED NEXT?

As long as the evidence supports a bullish primary trend, we would expect higher highs at some point in the future, which is exactly what happened after the low in 1987.  The primary trend was up before the plunge, and the primary trend continued after the plunge.

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WHICH METHOD LOWERS THE ODDS OF A MISSTEP?

When the primary trend is strong and clearly up, as it is today, our goal is to try to navigate between a point A and a point B that could be several years down the road.  If we review the two hypothetical examples above:

  1.  Trying to trade between points A-B-C-D-F-G-H-I-J and
  2.  Trying to hold between points A and B,

Which method appears more logical relative to the primary causes of most financial market missteps?

  1.   Trying to avoid volatility
  2.   Failing to understand what normal volatility looks like
  3.   Making short-term decisions based on fear and emotions
  4.   Failing to clearly define our objectives
  5.   Failing to develop specific strategies and tactics 
  6.   Narrow framing
  7.   Underestimating the psychological aspects of successful investing
  8.   Ignoring/fighting the primary trend
  9.   Making things overly complex

ARE MARKETS EASY?

No, in fact, markets are very difficult, which is exactly why it can be extremely powerful to simplify by focusing on the primary trend and long-term probabilities.  The plunge in 1987 takes on a whole new meaning when viewed in the gains before and gains after context below.  It is quite possible we will be able to say the same thing in several years about the "plunge" in 2018. 

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BALANCE OF 2018

As long as the evidence says the primary trend is up, our bias is to hold.  If higher highs will eventually be in the cards, focusing on where stocks may be in 3 hours, 3 days, 3 weeks, or even 3 months is not particularly helpful, and most likely would be harmful.  If the evidence begins to say the primary trend is in doubt, we will adjust accordingly.  That may happen, but it has not happened yet. 

 

FAQ - MARKET MODEL

Stocks: The Pause That Refreshes

A February 13 post reviewed several post-plunge market profiles that featured a period of consolidation, including the 1987 case below.

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WE NEED A HEALTHY CORRECTION

In 2018, prior to the recent volatility, the S&P 500 was rising in a manner that caused many to say, “we are in desperate need of a healthy correction”.

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MILLION DOLLAR QUESTION

In the markets, simple tends to be more effective versus complex.  Therefore, in the wake of the long-awaited “healthy 10% correction”, it is prudent to ask does the present day look like:

(1) A correction within the context of an ongoing bull market, or

(2) The early stages of a new bear market?

Why are these simple questions so important? If the answer is “a correction within a bull market”, it implies patient investors will be rewarded with higher highs (and higher profits) in the coming weeks/months.  If the answer is “a new bear market”, lower lows are on the way. 

THE PRIMARY TREND

Ultimately, we are asking if the primary bullish trend is still in place or is it looking vulnerable to rolling over into a primary downtrend.  If we take the chart above and add in a simple trend reference point, the 200-day moving average, we have to lean toward the "this looks like a correction within a bull market” answer.

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If the primary trend rolls over and morphs into a long-term bear market, we would expect to see price drop below the 200-day moving average - today it remains above the 200-day.  More importantly, when the primary trend rolls over into a long-term downtrend, the slope of the 200-day moving average flips from positive to negative as it did near the major market tops in 2000 and 2007.

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WILL A TRADE WAR BRING DOWN THE BULL?

A fair counter to the 200-day charts above is “that is one data point”.  This week’s video looks at numerous data points on numerous timeframes to help us better understand the market’s vulnerability to a bear market in light of recent developments regarding tariffs.  The primary focus of the video is monthly Bollinger Band signals for the S&P 500.  As shown in the video, Bollinger Bands were very helpful prior to and during the stock market’s major peak in the year 2000.  The video compares and contrasts 2018 with the hard data in 2000.

ALL TRENDS PAUSE FROM TIME TO TIME

The expression "the market needs to consolidate its gains" speaks to the need for a healthy pause/pullback/correction within the context of an ongoing bullish trend.  As of this writing, the facts we have in hand tell us the odds favor higher highs in stocks in the weeks/months ahead. 

As always, we will continue to take it day by day, remaining open to a shift in the observable evidence and bull/bear probabilities.  As noted in early January, assessing the odds via charts/hard evidence was extremely helpful in terms of remaining invested with the primary bullish trend in calendar year 2017.

HISTORY SAYS STOCKS CAN KEEP GOING UP

While it may seem implausible for stocks to continue to rally for many years, history says stocks can keep going up, as covered on January 16.

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