Recently, I have explored the topics of the effect of personality on your trading and investing risk management, position sizing, and different analysis styles like technical and fundamental. In this post, I will delve into the current market conditions analysis, which I feel is extremely important and should be a crucial component of every successful trader’s toolbox.
When I started out years ago, I was a pure “Warren Buffet” type value investor. As a result of this, I was solely interested in what people might refer to as “bottom up analysis” of a company I admired and was considering investing in. Its current financial position, its earnings, its competition, its prospects, and its valuation are all factors I looked at most carefully. I would buy without any additional hesitation if it was cheap enough, and good enough.
I was very naïve, and certainly no Warren Buffett, who is an absolute master of industry dynamics.
Much later on, when I grew very interested in technical analysis and pretty much abandoned value investing, I became obsessed with only looking at the charts and the stock’s price action. All I cared about was whether it was trending up or down, where its support and resistance were, and the question of whether there existed a head and shoulders pattern, as well as other technical criteria.
In the last eight years, however, I have become more market driven and therefore am now studying where the current conditions of the market are and base my view on economic data. I moved from “bottom up” to “top down” analysis.
Luckily, I one day came to my senses and realized that the best approach is actually an amalgamation of all three approaches. The importance of market analysis lies mainly in how it allows a trader to put together an understanding of the market’s direction in both the medium and long-term, and of whether we should continue in our participation. Please be aware that this is not market prediction. I do not feel anyone, including myself, is able to be right all the time.
I have been investing and trading in the stock market for over 20 years now. My experience has indicated that the market drives around 80% of the movement of an individual stock in the short term. This is one of the reasons why market analysis is so important.
Unfortunately, the majority of trades only focus on:
- Finding a stock
- Searching for technical entry signals
- Attempting to enter “perfectly”, putting out of their mind that over three quarters of the stock’s movement will be affected by the overall, general direction of the market.
On a completely different side of the spectrum exists value investors. Value investors care only about the fact that a given stock is cheap enough to purchase immediately, and do not heed where the market is.
Occasionally, I wonder why they do not simply choose to wait, if required for perhaps a few extra days, thus possibly giving themselves the opportunity to buy at a much cheaper price due to the general effect on the price that the market causes.
While history does not create an exact replica of itself, it is certain that there are resonances and similarities between the patterns of the past and present, and ignoring history is not a wise idea.
In order to successfully trade and manage the funds of others, I am consistently studying the current environment to put together my own view and idea of whether the market is; bullish, bearish, or sideways. This helps me to determine whether I should participate currently.
The study of history is useful in assisting you in avoiding being adversely affected by another GFC and other market declines that are caused by man.
I use my perspective on the market to discern my position when an opportunity comes up, through putting market analysis to work. Market analysis is useful in that it gives the trader the chance to form their own opinion on the market and make an informed decision on whether or not it is safe to participate. This process is very useful in reducing one’s overall portfolio risk.
So know where the market is at and take advantage of this as it will set you apart from all other average traders who trade stock in isolation to the overall market.
Remember to “be fearful when others are greedy, and greedy when others are fearful”.
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