The one constant about the United States equities markets
is its unpredictability. Just when the market slipped below
some record low price about three weeks ago and the indices
seemed headed for a downtrend a host of earning reports and
economic data combined last week to gave the popular Dow Jones
Industrial Average, the Nasdaq and the Standard and Poors
(S&P) 500 indices their first green week in a long time.
In fact the S&P 500 had its best weekly performance since
While for the casual observer and perhaps some institutional
holders a green week is good by any standards, for the active
trader last weeks sudden shift in market direction could
have made the going very difficult. In fact, the bulls very
well may have been helped in keeping the broader markets
three per cent surge intact, by the number of short sellers
that were being stopped out of trades.
Financials and technology stocks in particular posted sharp
gains while the pharmaceutical sector made an abrupt about
turn and, up to a few days ago, was challenging highs dating
back to 2004.
Before last week the market had seemed to have finally signaled
a clear trend going into the normally lower volume summer
months. After some weeks of tug or war when the market swung
from highs to lows, the indices broke some record lows to
finally give the bears a lead in the race for control of July/August
Of course the huge sell-off (the Dow shedding more than 400
points) was driven in part by the surge in oil prices and
Middle East violence, factors which are still keeping the
revitalised bulls in check. But with the earnings of several
companies beating analysts expectations and a slowing US economy
being taken to mean the Federal Reserve will no longer raise
interest rates, investors finally found enough positives to
drive the market upward.
If the upward momentum could be maintained over the next few
weeks then the bulls would have delivered a surprise knock-out
blow to the bears and the market would have begun to develop
a clear trend.
And for the active traders, for any trader/investor in fact,
a trending market is one of the best in which to trade.
There is power in trading the trend. The trend, simply put,
is just the general direction of the market and is often signaled
by indices or stocks making higher lows in an uptrend or lower
highs in a downtrend over a defined period of time.
Since trading is about playing the odds, with a stop loss
as your insurance policy, then the odds are always in your
favour when you trade in the direction of the trend. As the
saying goes the trend is your friend. Trading against the
trend multiplies the risk, lowering the odds regardless of
how strong or weak a company may seem.
I had this argument with a friend last week who by all his
fundamental assessments of Ebay was certain that it was a
classic buying opportunity.
I agreed with him on the fundamentals but in the overall context
of the market direction, the sector (Ebay is an internet software
company in the technology sector) and the trend the stock
has been trading in within the last few months, I couldnt
disagree more that it was an opportune time to buy. The fundamentals
may be but the odds were and still are totally against buying
The stock may eventually go up but the current odds favour
a further fall for sometime before a move up. Why go in now
to endure the pain of losses before seeing gains? Why tie
up precious capital in a stock whose odds favour a down move
for a while before any turnaround?
In fact with the stock rallying on July 11 it offered a great
opportunity for a short. In fact a short seller on that day
would have gained at least four dollars on Ebay by last Fridays
While the market in general remains volatile clearer trends
are developing in some sectors in either direction.
Consumer-oriented sectors such as retail and consumer discretionary
were slammed a few weeks ago and while they recovered somewhat
they are still pointing down. Both are now in major downtrends
having undercut several record lows. Telecoms too crashed
badly, down continuously for a month, with last weeks
rally still not to reverse its downward pattern.
The banking and drug sectors have both turned sharply upwards
and are signaling a likely change of direction for some weeks
to come. Strength could also be found in the defense sector
and oil with prices soaring above $75.
Biotechnology stocks also swung around but not enough so that
a few days ago it had already began to come back down keeping
it in the downtrend it has been in for more than a month.
The point is that if one trades equities in any of these down
sectors one would still be well advised to short stocks not
buy. In times such as these it usually takes more than just
a good earnings report to bring a sustained rally in a stock.
In downtrend markets, rallies are only opportunities to short.
Of course if the bulls really take over in the next few weeks
then the pullbacks are buying opportunities.
Actively trading the market is not the proverbial David and
Goliath scenario. In the stock market the Goliath trend usually
wins. Finding and staying on its side regardless of the time
frame is the wisest thing to do.
More than that, trend trading assumes that the stock would
continue to move in one direction for a longer time and therefore
it is closer to the traditional buy and hold strategy, which
many investors still cling to. The difference with the active
trader in trading the trend however, is the stop. Active traders
actively use market timing tools which in trend trading would
usually result in the trader having a tighter stop. The first
signal of a trend reversal would get the trader out of the
trade without giving back much profit.
Again, the trend is your friend. While there are strategies
to trade against it, a good rule of thumb in trading developed
markets is to make sure you are generally on the side of the
indices in as many time frames as you possibly can.
The more you can achieve that the more odds you stack in your
favour. Never become an opponent of the market. It destroys
with callous force.