By: Chris Rowe —
November 13, 2018
The 3 Key Money-Making Ingredients
The stock market just bounced off of a major market low.
People are wondering if there will be another leg lower, or if that was it.
Considering the way the stock market has been pounded into the ground lately, I thought you might benefit from the following:
I've learned a few things over the past 23 years in the industry (of pro money management and market analysis). And I've spoken to thousands of individual investors about their biggest challenges.
You'd be amazed to learn just how simple investing or trading can be once we remove our own personal fears and self-made barriers.
One way to do this is to think about making money in the financial markets as being made up of three key ingredients:
- Market Clarity...
- Historic understanding...
- Risk Management Strategy.
Forget about forecasting or predicting - it doesn't work consistently.
Market clarity means a very clear understanding of what is happening in the financial markets right now.
Also, focus on the "True Market" indicators and not what the industry has trained unsuspecting individual investor to focus on.
You can’t get the kind of market clarity I'm talking about by following a popular stock market average of 30 stocks like the Dow... or even 500 U.S. stocks like the S&P 500 (which only focuses on large-cap stocks).
To look at the Dow Jones Industrial Average and say “the market is doing well” is similar to saying “people in the U.S. are doing well”.
You'd be making a huge assumption about a lot of individuals or groups of people.
Furthermore, small-cap stocks tend to lead the direction of large-cap stocks so if you only focus on the major averages, you'll always be behind the curve. Instead, focus on "internal market indicators" (a.k.a., "market breadth indicators").
At this moment, these types of indicators all say we are historically oversold. That means, no matter how scary it might be to "strap on a pair" and BUY, history shows that somewhere around here is the perfect time to do so. Just make sure you're in the right sectors (not defensive sectors, like Utilities and Consumer Staples).
After using market data to clearly gain an understanding of what’s (really) going on in the market... all you then have to know is “What typically happens next in situations like this”?
That's where your historic understanding comes in. Historic understanding doesn’t mean you have to memorize every past action of the financial markets. You only have to know a few general rules and build on them over time.
When you nail down what a human’s path has been, then you can assign probability to what is likely to happen in the future. That's what insurance companies do.
In financial markets, when we look at what the price-paths have been, what we're actually looking at is a record of how a large group of humans have been behaving.
Here's a quick glance at one internal indicator. Who cares, at this moment, what it is. The point is to match the arrows on the upper chart to those on the lower chart.
The lower chart is the S&P 500, which doesn't give a truly accurate picture of what's truly happening in the stock market, but at least you'll get the general idea.
To see one example of how the S&P 500 (or any major market index) doesn't give a truly accurate picture of what's truly happening, look at November 2008 (red arrow) to March of 2009. For most stocks, the bear market ended in November 2009, four months before it was reflected in the S&P 500.
After market clarity and historic understanding, it comes down to managing your risk.
Even though there is a 50% chance that a flip of a coin will either land on heads or tails, that doesn’t mean it'll never come up tails 10 tosses in a row. Unlikely things do happen (they're called "black swans"). To be successful, we have to position ourselves to not get into trouble when they do.
As long as we manage our positions properly and we play only for high probability outcomes, we should make money.
PUTTING IT ALL TOGETHER
It may seem like I’m oversimplifying what some of the world’s most successful investors taught me over the last couple of decades.
But people lose money when they overcomplicate things.
In our educational programs (Options Soup and Technical Analysis Millionaire) we teach our trainees that it pays to keep it simple.
“Market clarity” is a less stuffy term than “market analysis,” and it more accurately describes what great market timers are really doing.
When people hear the word “analysis” they tend to think about math equations... having the right information that nobody else has in front of them... squiggly lines on price charts and so on.
Most people feel as intimidated by the term “analysis”, and by the tools analysts use, as I do when I lift up the hood of my car (“wtf?”).
But I've found that, once people get past the new lingo and grasp what’s making the squiggly lines squiggle, they always seem to realize that the charts and data are not difficult to manage.
Since the financial markets move based on human decision-making, it’s pretty easy to form an accurate opinion about what’s likely to happen next.
I have a pretty good idea what growth phases my children are likely to go through in the coming 12 months, even though I can’t be 100% sure. Similarly, we know, based on history, that there is a general path and natural progression that humans follow in the stock market.
Knowing that, we just have to position ourselves to work with what is likely to happen next. We'll deal with the odd "outlier" events as they come.
That’s why, I never robotically tell folks in my educational programs stuff like: “When the blue line crosses the red line it means you should BUY”! Instead, I make sure they understand why the chart is doing what it’s doing. We look deeply into what thinking (or what motivations) influenced the decisions of various market participants.
And I make sure they know how to use tools to gain a crystal clear understanding of what’s happening in the financial markets.
Never just accept what the media tells you is happening in the financial markets. You’d be surprised how little they really know. (Actually, in today's era of "fake news", maybe you wouldn't be surprised after all.)
Don’t feel discouraged if you don’t understand something about the financial markets, because I've seen some of the smartest, most experienced investors/traders look up some pretty basic terms when they think nobody’s looking. It’s normal. You don’t have to memorize everything about the market to succeed.
Just conquer any personal feelings of intimidation... or set aside any preconceived notions about the financial markets... and you'll be rewarded big time for your bravery.
If you can accept that people are generally predictable, then you probably know a lot more about the market than you realize!
And as always, trade safe!