By: Chris Rowe — September 3, 2019
The most successful investors are the ones who can completely eliminate emotion from their actions. They never look at the stock market as a gamble, but more like a business.
Therefore, they only take positions when they know the odds weigh heavily in their favor.
It follows, then, that clearly seeing the market, not predicting it, is the most important skill to develop throughout your investing life.
Your goal is to acquire the ability to understand the current market. Once you have that ability, you can apply the laws of probability based on history.
Do this, and you'll find yourself only placing bets on high probability outcomes.
A common mistake investors make is, they learn the “magic” of one indicator, and then get so excited they run out and use that one indicator to time all their trades.
Inevitably, he or she learns an expensive lesson. Don’t make that expensive mistake. (I've already made it for you when I was starting out; so learn from me.)
One key ingredient is Synergy -- the working together of two or more things to produce a combined effect greater than the sum of their separate effects.
Put another way: The whole is greater than the sum of its parts.
Think about the way a doctor diagnoses a mysterious health problem.
The doctor evaluates the patient’s symptoms one at a time, and, based on several different clues, comes up with a diagnosis.
The doctor doesn’t base the diagnosis on one single clue, but a number of clues taken together which either all or mostly point to the same thing. (Have you ever left the doctor’s office feeling uncomfortable because he or she didn’t seem to ask you many questions before giving you their "solution" to your problem?)
Any doctor who treats an unusual health problem based on one single clue is likely to recommend the wrong treatment. On the flip side, the doctor increases the odds of a correct diagnosis with each clue, symptom or indicator. Since health is such a serious matter, doctors have to take this synergistic approach of patient evaluation.
The patient might decide to take it a step further and get a second and third opinion. This approach is used for the same reason a doctor looks for many and varied clues before recommending treatment: to increase the odds of success.
The second and third doctor that the patient sees might even say that the first doctor is absolutely wrong, which might save the patient from an unnecessary surgery.
Your health is more important than your wealth, but your wealth is also a very serious matter.
Just as a doctor increases the odds of a successful treatment by using several different clues, you can tremendously increase the odds of a successful trade by using a number of indicators to confirm what another is telling you.
And the luxury that you have when diagnosing a stock (which the doctor doesn’t have), is that you can choose to walk away from a situation if the clues don’t add up.
When reading a chart, a common form of synergy is to look to see if the volume is confirming the validity of the price action.
Another synergistic approach would be to see if the long-term picture (the trends, support and resistance, and/or moving averages) is confirming what the shorter-term picture (trends, support and resistance or moving averages) is telling us.
We might use momentum indicators to confirm what the chart pattern and volume are telling us.
After momentum indicators and volume confirm the stock price action, we might consider seasonality. For example, we would consider whether we are in a time of year that’s typically strong or weak for the stock market.
We might cross reference that information with how strongly the peer group (industry group) is performing.
We might also consider which year of the 4-year election cycle we are in.
We might also use breadth indicators to gauge the health of the market.
We may even take it a step further and look up the investor sentiment readings.
When using one indicator to confirm what another is telling you, be sure to use dissimilar indicators -- that is, indicators that are not similar.
For instance, you wouldn’t use one momentum indicator to confirm what another is telling you. You wouldn’t use one breadth indicator to confirm what another is telling you.
Instead, you might use a breadth indicator to confirm what a momentum indicator is telling you.
Remember, no indicator is perfect. The more confirmation you have (the more dissimilar indicators that say the same thing) the more the odds are stacked in your favor.
If you don’t feel that you have overwhelming odds of success, then don’t get involved.
Think about it: if you are sitting on cash instead of stock while the stock market moves 8% lower, then you’ve just beaten the market by more than 8%!