The Key Difference Between Capturing Big Gains And Big Losses In The Stock Market

FINE LINE BETWEEN WINNING AND LOSING

Have you ever looked back after the market gains 20% and said to yourself how did I not capture more of that move? 

Did you look back after the 2000-2002 or 2007-2009 bear market and ask yourself how did I let myself lose that much money? 

This week’s video explains why those horrible experiences are so common in the stock market and covers methods to minimize the odds of repeating past investing missteps.

VIDEO CORRECTION: At the 13:31 mark, the summary table for CASE B should be 56% and 44% as shown here. 

Markets Look To Complete Important Bullish Step

CLUES BACK IN FEBRUARY

A February 26 post outlined the longer-term risk-on implications of trend flips in the stock (SPY) vs. bond (TLT) ratio and the tech (VGT) vs. bond (TLT) ratio.  Rather than having growth-oriented stocks making a new high relative to defensive-oriented bonds, we would expect bonds to be leading in a "fear of a recession and bear market" scenario as shown on February 5.  The chart below favors bullish probabilities. 

S&P 500 TRYING TO REGAIN BULLISH FORM

When a market corrects and enters a short-term downtrend, three things need to happen for the primary bullish trend to regain control.  Step 1 is breaking above a downward-sloping trendline (see chart below).  Step 2 is making a higher low above the previous lowest low.  Step 3 is making a higher high.  The S&P 500 closed above 2,779 on March 9. 

A close back below 2,779 does not negate the short-term bullish and probability-related progress; for that to occur the S&P 500 would have to make a lower low below the Step 2 point (2,677) in the chart above, which is entirely possible.

The further the S&P 500 moves above 2,779 in the days and weeks ahead, the more meaningful it would become from a bullish perspective.  Conversely, the further the S&P 500 moves below 2,677, the more meaningful it would become from a bearish perspective.  Nothing is binary in the financial markets. 

TECH STOCKS REGAIN 100% OF CORRECTION DRAWDOWN

Tech stocks were a leading market sector before the 2018 correction, as noted back in June of last year.  Typically, it is a good sign for the broader market when economically-sensitive leaders resume their leadership, which is exactly what has happened in recent weeks.  The NASDAQ printed a new all-time high on Friday, March 9, 2017.

DO THE CHARTS SUPPORT THE BEARISH HYPE?

This week's video objectively compares 2018 to a bullish period and a bearish period.  The video also follows the S&P 500's primary trend step-by-step between January 8 and March 8, allowing us to see the incremental impact of the recent spike in bond yields, tariffs, and Gary Cohn's resignation.  

INDUSTRIALS HAVE SOME WORK TO DO

Is it alarming that the Dow has not made a "step 3" higher high yet?  No, there is no market law that says all three major indexes must do everything in unison.  If we are 3 or 4 months down the road and the Dow is still treading water, then it would be more concerning.  To make a step 3 higher higher high, the Dow needs to close above 25,709.

THE PRIMARY TREND REMAINS BULLISH

The charts above provide some odds-related insight into a resumption of the market's bullish primary trend.  Since we know it is not unusual for markets to bounce around in a volatile and confused manner after a waterfall decline, it remains prudent to take it day by day focusing on the health of the primary trend.  If the primary trend starts to wane, we will adjust as needed. 

Do The Charts Support The Bearish Hype?

After reviewing the fatcs, you can decide. 

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.

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. 

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. 

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.  

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.

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.

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. 

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