To me, the "tape" is the final arbiter of any investment decision. I have a cardinal rule:
"Never fight the tape".
I also follow closely the degree of OPTIMISM and PESSIMISM in the market place.
Big money is made in the stock market by being on the right side of the major moves. I don't believe in swimming against the tide.
I want to see if the stock acts well relative to the market before I buy it. I find that buying on strength gives you an edge. You must pay a premium, but you increase the probability of being right. The idea is to buy when the probability is greatest that the market is going to advance (not to buy at the bottom)
I consider myself both conservative and aggressive. By nature I'm conservative. I'm very risk adverse. But there are times when you have to be aggressive. The problem with most people who play the market is that they are NOT FLEXIBLE.
Summing up, to succeed in the market you must have DISCIPLINE, FLEXIBILITY - and PATIENCE. You have to wait for the TAPE to give its message before you buy or sell.
In playing the market, remember you must deal with probabilities, employ sensible strategies to limit RISK, and get aggressive ONLY when conditions warrant.
The worst thing about INFLATION is that the CURE is more DAMAGING than the disease. When inflation gets too intense, the Federal Reserve starts acting to reduce the growth in the money supply, thereby increasing interest rates. This slows economic activity and hurts corporate profits. The result is often a Bear market.
Monetary conditions exert an enormous influence on stock prices. The monetary climate - primarily the trend in interest rates and Federal Reserve policy - is the dominant factor in determining the stock market's major direction.
Combining to produce a monetary "climate" are Loan Demand in the economy, Liquidity in the banking system, Inflation/ Deflation, and policy decisions by the Federal Reserve Board. These are major factors that create a trend in interest rates.
Generally, a Rising trend in Rates is BEARISH for stocks; a Falling trend is BULLISH.
The Trend is your Friend
I have found that Strength does indeed tend to lead to greater Strength.
Pessimism means there's an abundance of CASH
Analogy about launching a rocket to the Moon:
The first rally must have a tremendous surge for a major market advance. If it does, it generates more buying enthusiasm and brings in people who missed the first move. It prevents a large correction because that first rally reserves the market psychology. People who missed it are sitting there loaded with cash and eager to get abroad. So, after the smallest setback, new buyers enter and there is no sharp correction.
One of the frustrating things for people who miss the 1st rally in a bull market is that they wait for the big correction and it NEVER comes. The market just keeps climbing and climbing.
Fighting the Tape - An invitation to Disaster
I can't overemphasize the importance of staying with the trend in the market, being in gear with the tape, and not fighting the major movements.
In the stock market, there is always some bearish evidence and some bullish evidence. You never have difficulties in unearthing clues to back your viewpoint.
In the stock market, when the crowd gets too large, they tend to follow the WRONG signs near the market Tops & Bottoms. Consequently, many investors find themselves outside looking in when the market surprises them and changes direction.
The best gains made in bull markets tend to come in the first 6 months of a fresh bull market, when profits are usually DECLINING.
Not only is there tremendous pessimism before this initial rally, but that 1st rally traditionally is NOT believed.
The shrewd investor, going against crowd behavior, has 2 clues near a bear market bottom:
(1) extraordinary pessimism among the crowd at the bottom, and
(2) continued skepticism and pessimism during the first sharp rally in the bull market.
At the bottom of bear markets the crowd has been hammered too many times and regards the 1st true rally in the new bull market as an OPPORTUNITY to Sell. The crowd tends to be WRONG at exactly the WRONG time.
Near the top of the market, investors are extraordinary Optimistic because they've seen mostly higher prices for a year or two. The crowd anticipates higher prices, and it "knows" that even if a sell-off comes, it will only be another buying opportunity and eventually will lead to still further advances. At the top, optimism is king, speculation is running wild, stocks carry high P/E ratios, and liquidity has evaporated.
The idea is: Beware of the crowd when the crowd is too one-sided.
Very few secondary distributions are seen once a bear market gets rolling. People are not interested in buying more stock at those times; moreover, if prices are depressed there is less interest by corporate or individual holders in selling such blocks. However, when bull markets heat up and speculative froth is in the air, the number of secondaries increases markedly.
The number of secondaries is an excellent barometer of excessive speculation near tops when the figures gets quite high. When the number of secondary offerings dips to extremely low numbers, it's a sign of lack of speculation enthusiasm in the market, which implies pessimism. And that is often the harbinger of a market bottom.
Major Bull and Bear Markets
I would estimate that stocks spend only about 20% of the time in the most active phases of the bull trend and only about 10% in the severe downward periods of major bear markets. Roughly 70% of the time stocks either meander in a neutral trading range or undergo minor rallies or declines within their various bull and bear cycles.
2 basic ingredients for Bull: (1) Advance/ Decline Indicator; (2) Fed Indicator
3 crucial conditions for Bear: (1) Extreme Deflation (Producer Price Index); (2) Ultrahigh P/E; (3) Inverted Yield curve (when ST interest rates > LT interest rates)
How to pick the Winners
What I am looking for are reasonable gains in both Sales (Revenues) and EPS
First place to start is with the Market's recent action as a whole. Suppose the market has been very strong of late. Obviously, then I am going to eliminate any stock that hasn't been keeping pace... My theory is that if a stock is really good, it should be acting at least as well as the market.
In a very strong market, the very best kind of action is a clear Uptrend on a chart where you see a series of higher highs and higher lows - sort of a stepladder on the way up. The best buying spots are ST pullbacks of 5%-10% from a high, provided that the small downmove does not violate a recent prior low.
If the market as a whole is moving sideways for some period, then a worthwhile candidate might be one that is just breaking out from a long basing period.
Recognizing the relationship between trends and the industries that might benefit from them can lead to above-normal returns... A major economic trend might develop, such as inflation, disinflation, low interest rates, foreign competition, weak dollar, etc., which may lead to excellent LT investment opportunities in certain industries.
Whether you are right or wrong about the LT economic trend, it is important to REJECT picking any stock that violates your PERCEPTION of the trend...If you purchase a stock greatly at odds with your own feelings, you're going to be very uncomfortable with it, and you'll probably sell it on the first tiny reaction, or tempted to get out with a very small profit if it rises a bit.
If you hold too much of a position, you're apt to worry about it excessively and often wind up selling it too soon.
A small loss, when realized, becomes an opportunity for profit elsewhere. It gives you the chance to turn a liability into an asset, instead of just sitting there praying that your old stock will come back.