There are several ways that helps us to determine the market condition:
One, is the failure of stocks to respond to good news. Investors should take note whenever such announcements are made and the market does not respond, it means that serious trouble lies ahead. This is because such news are already factored into the market and the market had already run out of steam. What’s next? Expect sharp reversal of the market to follow.
Two, it is exactly the opposite of the first symptom. During the bull run, whenever there are bad news announced, stocks are still advancing. This happens because stock promoters and market makers are doing their best to support stock prices so that they can distribute as much stocks they can before the impending fall.
Three, another pattern that need to be identified is the volume build up without the commensurate advancing in stock prices. Such conditions represent what we called ‘distribution’ by informed investors.
In order to recognize the distribution of stocks, we need to study the high, low and volume traded of leading issues. If the leading issues are trading at the same or lower price than yesterday’s closing but with a much higher volume then we can conclude that someone is unloading the stocks. Then we can anticipate a downturn in the leading issues in the next few days.
Four, if the volume of the overall market is trading at record levels then investors need to Be careful. Normally under such conditions, it represents the euphoria stage (see chart above) and this is where every mother’s sons and daughters will be talking about stocks. There will be a lot of experts offering advise and stock market will be the leading topic of choice be it during cocktail parties or wet market gatherings. Nevertheless, the print media will be doing its utmost assistance to the investing public by publishing news on the market day in day out. To an informed investor, it’s game over and time to leave the party.
As an investor we need to keep a clear head at all times and not influenced by the daily gyrations of the financial markets. This is due to the shifting from fear to greed and vice versa by the crowd. It is not easy to avoid being caught up in a stampede in the different end of the bull and bear markets. Nobody wants to be left behind during a bull or a bear market rush where the herd is moving. So it is very important to keep your head when others are about to lose theirs.
Never follow the Crowd: More wrong stocks are sold during panic selling in crisis and bought during panic buying in bull markets than any other times.
Panic Selling: Most of the time you will find that a few days after the announcement the stock price will rebound back to or higher than the original price. The reason being insiders, shrewd investors and other people in the know had already sold their shares at the higher price before the announcements. When the news is announced they have the pleasure of relieving those investors who panicked by buying their shares at a lower price.
Panic Buying: Panic buying occurs when there is good news announced like a contract is sealed, a merger and acquisition exercise, a strike had been settled, a discovery of large mineral deposit and etc. This is the time where investors felt that they don’t want to be left behind in the anticipated price hike in the shares. People just rush in and start bidding the share price to ridiculously high price. End result will surely be profit taking and will result in a much lower price in the next few days.
The problem with both investors and speculators are they do not know when to sell because buying is easier than selling. When come to investing we will need to differentiate between hope and reality. When market turns against us, we need to either take profits or cut losses. As we have said earlier it is easier to buy than sell and taking profits will not make you broke.
Stop-loss strategies are commonly used by investors to reduce their holdings in risky assets if prices or total wealth breach certain pre-specified thresholds. We derive closedform expressions for the impact of stop-loss strategies on asset returns that are serially correlated, regime switching, and subject to transaction costs. When applied to a large sample of individual U.S. stocks, we show that tight stop-loss strategies tend to underperform the buy-and-hold policy in a mean-variance framework due to excessive trading costs. Outperformance is possible for stocks with sufficiently high serial correlation in returns. Certain strategies succeed at reducing downside risk, but not substantially