Market Timing in Trendless Markets
12/12/2011 12:01 pm EST
Sideways or range-bound markets are tough on market timers, but by making adjustments, tempering expectations, and staying committed to the strategy, timers can stay on track and be prepared when a trend reappears.
We have received so many e-mails from subscribers who are concerned about the incredible stock market volatility and small back-and-forth trades over the past several months that we felt this week's report should focus on just that subject.
We encourage you to look at charts of the S&P and Nasdaq covering the last five or six months. The market is in a trading range and has actually gone nowhere, except up and down within that range.
Sideways markets are always tough on market timers, and the current markets are no exception.
We put together this report to answer your questions. We hope that by reading it, you will have a clear understanding of what our strategies are designed to accomplish, and what traders can expect.
What Exactly Is a Trend?
Trends can be found in all time frames. On a one-minute chart, a trend might last an hour or more. On a five-minute chart, a good trend might last several hours. On a daily chart, a trend will be several months or longer in duration, and on a weekly or monthly chart, a trend is likely to be measured in a year or even years.
To time mutual funds, nothing less than a daily chart can be used, and for a trend to be long enough to be successfully timed, it needs to last at least two months, but trends lasting four to six months (or longer) are the real profit makers.
Take a look at that chart again. We have not had a trend lasting that long since early-March 2011. As the markets are more often than not in a trend, this is a very long time to be going sideways. We are either in the process of developing a base for a new upward trend, or at the top of a new bear market.
Importantly, no one knows which direction it will take when it finally begins.
Anyone can identify a trend when looking at historical charts; after all, they are history. But market timing involves identifying future trends, and doing so early enough so that they can be traded profitably.
To identify a "potential" trend, a good timing strategy must wait until at least some proof of a trend has been established. That usually means at least approximately 5% of a trend will have already occurred before we can issue a signal and trade it.
To just jump on board after a one-day rally would be irresponsible. The potential trend must have already started and have some staying power.
In a "trendless" market, we may get the signal after that 5% start, but a true, lasting trend, never materializes. Instead, several days or weeks after we enter the new "trend," the market reverses.
A true trend does not develop. This results in back and forth trades that end in small losses, as well as small gains. It can also result in several small losses in a row, or several small gains in a row.
Avoiding Back-and-Forth Trades
Can we avoid the small back-and-forth trades? Certainly. We can trade on weekly or monthly charts. There will seldom be back and forth trades, but we would also miss the first 10%-15% of a real trend when it starts. We chose not to do this.
Our conservative strategies trade in weekly time frames and they have been in cash for over four months.
That is great in trendless markets, but as we wrote above, no one knows ahead of time what the markets will be, so the aggressive strategies must trade those trends that are identified.
Would we have less of these small losing trades? Yes, absolutely, but we would still gain or lose in the ups and downs of a trendless market by staying unchanged in our position over that longer (weekly or monthly) time frame.
The same gains and losses are still experienced, and some losses may be much larger than our current timing strategies allow.
NEXT: Remember, (Small) Losses Are Inevitable|pagebreak|
The Price of Doing Business
What we are saying is that losses are inevitable! They are the price of doing business as a market timer. They are the price of doing business in the stock market, period!
Our timing strategies accept these small losses (and sometimes small gains). No one knows when the next trend will start, or in which direction the next trend will go.
Tradable trends only occur once or maybe twice a year. Sideways markets occur between trends, and this is where we are now. If a market timer cannot accept small losses, they will not realize the gains when a trend finally does start.
Our research shows that the markets are in tradable trends about 80% of the time. So this current trendless stretch is unusual. But it will end; and that is important to remember. The next trend is coming, and to be in it, we must make the trades.
Multiple back-and-forth trades in a trendless market are the price we willingly pay in order to ensure that we never miss a real trend when it occurs.
So we will continue to trade every potential trend until the next real trend begins. Then we will be on board, and we will reap the rewards of market timing.
Understand that our (and your) strategies should be designed to allow small losses and never to miss a trend. They should also be designed to never lose large amounts of capital in a bear market, and in fact to make money in a defined bear market if using one of our bull and bear timing strategies.
But in order to do this, all potential trends must be traded.
We hope this explanation helps. Keep your focus on the big picture. Do not agonize over every little back-and-forth move that occurs in a trendless market, or every "guru" who says he knows for certain where the market is headed next.
Do not lose sleep over news events that you have no control over, or daily rallies and declines that you also have no control over.
The gurus don't know what tomorrow holds; you don't know what tomorrow holds; and we don't know what tomorrow holds.
That is why we trade trends. That is why, over time, we always beat the market.
The key word is "time." The next trend will occur. It always does. When that will happen is not worth worrying about, as we will be profiting when it inevitably does occur.
By Frank Kollar of FibTimer.com