Market trends

Practice shows that it is wisest to invest and trade along the market trends. Most opportunities arise when the market is moving in a clear direction, and even if an investor has chosen not to include the best companies in his portfolio, he will still benefit from the overall market movement. 

It is useful for everyone to have their own method for determining the direction of the market. It is almost impossible for even professional investors to identify a change in market direction or a turning point, but each of us can have our own way of realising at the earliest possible moment that the market has changed direction and that there is a need to re-model our portfolio. 

In practice, moving averages are commonly used for this purpose. When the price crosses the moving average from above or below and the candle for the observation period closes below or above the moving average, a change in the direction of the price is indicated. This is what the theory says. But is this always the case? Again, each tool needs to be able to be applied and interpreted objectively. A lot depends on the period of the observed price or moving average. In order to identify changes in the long-term direction of the market, the author uses monthly and weekly price observation periods, as well as a number of moving averages and volatility, stop indicators. He also calculates mean reversion based on standard deviation. 

The most important thing is that each investor has to find the method and tools that are most convenient and suitable for him or her, and that will allow him or her to avoid major losses.

Since the largest daily changes (negative) in the market occur when the price is already below its long-term moving average, this indicator would help to avoid larger losses when panic among market participants gains momentum.

Following on from this, the second insight in this series of articles is that, once a change in the direction of the market has been indicated, it is important to draw the right conclusions in relation to one’s investments. 

The graph shows a study carried out by Javier Estrada, Professor of Finance, IESE Business School, University of Navarra, Spain

The graph shows what the results would be if an investor had no open positions on the ten worst days in the market (red curve), on the ten best days in the market (blue curve) and just always had open positions in the market (green curve). 

Timely indication of market direction and adapting to changes in conditions can lead to significantly better results in the long term. The more time an investor spends out of the market, he loses the opportunity to have invested his capital during the ten best days on the market (or at least one of them), and you can see the results on the graph for yourself in addition to these ten days. Also, a correct understanding of the indicators can help to avoid the ten (or one of them) worst days in the market and also to achieve extremely high results.