What follows is my Weekend Update for March 9, 2013 which I sent out to AllanTrends subscribers earlier this morning. In the 3 1/2 years I've been sending out Updates, this is the first one I labeled, "Important." Not that the others weren't important, just that this one was very important. Not that the others weren't very important, this one was very, very, important. You get the idea. Note especially the paragraph where I address the so-called "average 13% annual returns of the stock market," that paragraph is even more important than the others.
Weekly Market Analysis
I’ve covered this topic many times before, but it is so vitally important for making money in the market and in particular, making the highest and best use of this service, that I am covering it again.
Trend FollowingAt AllanTrends, we follow a proprietary trend line based on an Average True Range calculation that identifies dominant trends with a minimal (but necessary) amount of whipsaws. We take small losses as a price to pay for large, sometimes huge (GOOG, NFLX) gains. We use the trend line to exit or short stocks that are signaling the end of an uptrend and the beginning of at a minimum, an intermediate downtrend (AAPL). The same technique applies very effectively to intermediate and longer trends in market indices (DJIA, SPX and NASDAQ) as well as major commodity ETF’s (GLD, SLV, USO).
Trend following is an investment strategy based on the technical analysis of market prices, rather than on the fundamental strengths of the companies. It tries to take advantage of long, medium and short-term moves that seem to play out in various financial markets. The strategy aims to work on the market trend mechanism and is intended to be capable of making profits from both the ups and downs of the markets. Traders who use this approach can use current market price calculation…….and channel breakouts to determine the general direction of the market and to generate trade signals. Traders who employ this strategy do not aim to forecast or predict specific price levels; they simply jump on the trend and ride it.
The stock market is now entering a period of frothy market sentiment. In his February monthly Elliott Wave Theorist, Robert Prechter identified 16 separate market sentiment indicators indicating extreme investor optimism (Market Vane’s Bullish Consensus, money market fund assets at record lows, insider selling, margin debt, volatility index at record lows, etc.). A top is almost certainly in the making.
But as trend followers, we continue to be Long the U.S. stock market. Until (and unless) the intermediate trend turns down and so long as the dominant trend is up, as the late (and great) Martin Zweig observed, “The trend is your friend.” In the 1st qtr of 2000, the market topped with the Nasdaq entering into an 80% decline over the next two years. During that same time, the S&P fell 50%. Yet, Buy & Hold advocates point to a 13% annual gain in the stock market over the past 20 years to herald the wisdom of just, Holding. Tell that to any of us who sat through 50% to 80% declines in 2000-2002 and again in 2007-2008. The likelihood of most investors holding through bear markets is slim to none, while the chances of selling out at or near the lows is extremely high.
By following the dominant trend, such personal financial calamities are impossible. The AllanTrends proprietary trend line doesn’t get out at the absolute top nor get you in at the absolute lows. But it does protect about 85% of the gains built up in bull markets and avoids about the same percentage of decline in the bear markets. For the more active investor, those 85% declines can be very profitable by shorting stocks and indexes and with the advent of inverse ETF’s make it easy to make money on the declines by simply owning an inverse ETF (DXD, SDS, TZA).
In other words, enjoy the party while it lasts, but let’s keep one eye on the door for accounting purposes, i.e. first in, first out. Taking that a step further, be prepared to use our trend models and the inverse ETF’s to extract exit tolls from those running out the door behind us. To everything, there is a season.