Monday, December 14, 2015

Importance of objectivity in trend following

Market managed to put in a nice turn-around and must have made many market commentators happy. However, the market remains in a downtrend and in a bear market, according to our proprietary models. In a bear market, we expect to see nice rallies - rallies that can shake the shorts and lure in more longs.

Although we are still near the highs, as measured by $DJIA and $SPY, small caps, junk bonds and Global Dow are significantly lower. In facts, some of the major indices are completing Head and Shoulders patterns, shared in the last post.

From a socio-economic perspective, euphoria is the primary driver near the top. And last week's milestone climate agreement is a sign of remnants of euphoria of the bull market. We have talked about market psychology is greater detail in prior posts on the blog, so we won't get into that discussion over here. But we need to make sure that all the market analysis tools are good, but one can only make money in the market by being aligned with the broader trend.

No matter whether its a Bull Market or  a Bear Market, trend is your friend. I have seen people getting wiped out in both Bull and Bear markets because they fought the trend. Therefore, if the current market is trending down or we are in a bear market, one should not get excited about the rallies. In fact, in bear markets following are the keys actions an investors should take, depending on his/her risk profile and personal situations:

  1. Exit longs except for very solid dividend paying stocks (if cannot exit longs due to tax reasons)
  2. Enter positions in asset classes already in bull markets
  3. Short with a fraction of portfolio because shorting is very dangerous and is for professionals (link to sad story)
If someone wants to short, shorting an ETF is much safer than shorting an individual stock because of diversification. After all, risk management should be the top priority of every investor. Never the less, the most important part of any trade is to consistently be on the right side of the trade and hold on to positions for the longer-term to avoid short-term capital gains rates, which can sting at the end of the year, especially if your in the top 39% tax bracket.

Now the key to being on the right side is being OBJECTIVE in your assessment of the market.

Image result for objectivity
Although there are many ways by which one can bring objectivity into investments, UST team has done significant analysis on identifying Bull/Bear markets using objective statistical analysis techniques. At some point we will go into the details, but right now these models are saying that:
  • Stocks - Bear
  • Bonds - Bull
  • Bit Coins - Bull
  • Gold - Bear
In the next few posts we will discuss:
  • Elliott Wave analysis of current market
  • Alternative investments, according to their state
  • Asset allocation options
  • Tax implications 
  • Revisiting Objectivity and market trend

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