The Effect of News Events on the Market

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The Effect of News Events on the Market

Some charts of market averages list major news events that occurred at specific times during the last 12 months. This information can be extremely valuable, particularly if you retain and review old back copies. You then have a history over many years of the market averages, together with important news events that may have influenced the market's direction in the past.

History can repeat itself. If you have solid information about how markets behaved during certain past incidents, then you can develop better judgment for the future.

It is valuable to know, for example, how the market reacted in the past to a change of administration in Washington, rumors of war, wage and price controls, discount rate changes by the Federal Reserve Board, or "panic" news circumstances.

The chart on the next page of the general market averages shows several past cycles.

The Big Money Is in the First Two Years

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The Big Money Is in the First Two Years

Almost always, the really big money is made in the first one or two years of a normal new bull market's upward movement. This, then, is the point in time you must recognize as soon as possible and fully capitalize upon while the golden opportunity is there.

The remainder of the up cycle usually consists of back and forth movement in the market averages, followed by a bear market. The year 1965 was one of the few exceptions, but this strong market in the third year of a new cycle was caused by the advent of the Vietnam war. In the first or second year of a bull market, you should have a few intermediate-term declines in the market averages, usually lasting a couple of months, with the market indexes dropping 8% to occasionally 15%. After several sharp downward adjustments of this nature, and once two years of a bull market have passed, heavy volume without further upside progress in the daily market averages could indicate the
beginning of the next bear market.

Since the market is made up of supply and demand, you can decipher a chart of the general market averages almost the same as you read the chart of an individual stock. The better publications display the Dow Jones Industrial Average and S&P 500 in the front of their periodicals. They should show the high and low and close of the market averages day by day for the prior year, together with the daily New York Stock
Exchange volume in millions of shares traded.

Bear markets normally show three legs of price movement down; however, there is no rule that says you cannot have two or even five "down" phases or more. You have to objectively evaluate overall conditions and events in the country and let the general market tell its own story. And you should learn to recognize the story the market is
attempting to tell you.

Stages of a Stock Market Cycle

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Stages of a Stock Market Cycle

The winning investor should understand how a normal business cycle unfolds and the duration of these periods, paying particular attention to recent cycles. There is no foolproof guarantee that stock market cycles will last diree or four years because it happened that way in the past.

Dedicated market students who desire to learn more about cycles and the longer-term history of U.S. economic growth may want to write to Securities Research Company, 101 Prescott Street, Wellesley Hills, MA 02181 and purchase one of their excellent long-term wall charts. The stock market ordinarily bottoms out while business is still on a downtrend, anticipating economic events months in advance. Analysts refer to this phenomenon as "discounting of the future." In like manner, bull markets frequently top out and turn down before economic recession begins.

Therefore, using economic indicators to tell you when to buy or sell the stock market is generally an exceedingly poor procedure. Yet some firms have people trying to do this very thing. It's a somewhat ridiculous approach, but it does seem to make those
who don't understand the stock market very well feel better.

Ironically, economists also have a rather faulty record of predicting the economy. A few of our U.S. presidents, themselves lacking sufficient understanding of the American economy, have had to learn this lesson the slow, hard way. Around the beginning of 1983, just as the economy was in its first few months of recovery, the head of President Reagan's Council of Economic Advisors was a little concerned because the capital goods sector was not very strong. This was the first possible hint that this particular advisor might not be as thoroughly sound as he should be, because capital goods demand is never good at the early stage of economic recovery, and particularly so in the first quarter of 1983, when American plants were operating at a low percentage of capacity. You should check earlier cycles to learn the sequence of industry group moves at various stages of the market. For example, railroad equipment, machinery, and other capital goods industries are late movers in a business or stock market cycle. This knowledge can help you determine what stage of the current market period you are in. When these groups start running up, you know you're near the tail end.

Overbought/Oversold: Two Risky Words

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Overbought/Oversold: Two Risky Words

The short-term overbought/oversold indicator, which is avidly followed by some public investors, is a 10-day moving average of advances and declines in the market. Caution: Sometimes in the beginning of a new bull market the index will become substantially overbought because it has just come out of a long decline. This should not be taken as a sign to sell stocks. A similar occurrence can happen in the early stage or first leg of a major bear market when the index becomes unusually oversold. This event is really telling you that an eminent bear market may be beginning.

I once hired a well-respected professional who relied on such technical indicators. During the 1969 market break, at the very point when everything told me the market was beginning to get into serious trouble and I was aggressively trying to get several portfolio managers to liquidate stocks and raise large amounts of cash, he was telling them that it was too late to sell because his overbought/oversold indicator said the
market was already very oversold.

You guessed it, the market split wide open after the index was oversold and really started to decline.Needless to say, I rarely pay attention to overbought/oversold indicators.

What you learn from years of trying experience is generally more important than the opinions and theories of experts using their favorite indicator. Sometimes, the more widely quoted and accepted the market or economic expert, the more trouble you might, on occasion, get yourself into.

Who can forget the expert who in the spring and summer of 1982 insisted that government borrowing was going to crowd out the private sector and interest rates and inflation would soar back to new highs? The exact opposite happened; inflation broke and interest rates came crashing down. Conventional wisdom is rarely right in the market.

Psychological Market Indicators Can Help

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Psychological Market Indicators Can Help

There are several other indicators which may provide further data about the trend of the general market. The percentage of investment advisors that are bearish is an interesting measure of investment psychology. Near bear market bottoms, the great majority of advisory letters will be bearish, and near market tops, the majority will be bullish.

In other words, the majority is almost always wrong when it is most important to be right. The issue here is a question of degree. You cannot blindly assume that because the last time the general market hit bottom and 65% of investment advisors were bearish that the next time the advisors' index reaches the same point, a major market decline will be over.

One of the great problems with indexes that move counter to the trend is that you always have the question of how bad it can get before everything finally turns. In this line, most amateurs in the market follow and believe almost religiously in  verbought/oversold indicators.

Industry Action That Led to the Creation of Discount Firms

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Industry Action That Led to the Creation of Discount Firms

Some constructive changes were brought about several years later, after a more thorough and proper period of analysis and testing. However, it should be noted that when negotiated commissions were finally adopted to replace fixed rates, the end result was as follows: Many smaller research firms were put out of business or forced into mergers with industry giants, commissions to institutions were immediately cut in half, and commission rates to individual investors were actually raised several times, thereby laying the foundation for the successful development of numerous discount brokerage firms.

How You Can Spot Stock Market Bottoms

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How You Can Spot Stock Market Bottoms

Once you've recognized a bear market and scaled back your stock holdings, the big question is how long you should remain on the sidelines. If you plunge back in the market too soon, the apparent rally may fade and you'll lose money. But if you hesitate at the brink of a roaring recovery, opportunities will pass you by.

Again, the daily general market averages provide the best clues. Watch for the first time an attempted short-term rally follows through on anywhere from its third to tenth day of recovery. The first and second days of an attempted improvement can't tell you if die market has really turned, so I ignore them and concentrate on die follow-through days of the rally. The type of action to be looked for after the first few days of revival is an increase hi total market volume from die day before, with substantial net
price progress for die day up 1% or more on the Dow Jones or S&P Index.

There will be some scarce cases where whipsaws may occur; however, in almost every situation where the rally has a valid follow-through and then abruptly fails, the market will very quickly come crashing down on furious volume, normally the next day.
Just because the market corrects the day after a follow-through, however, does not mean the upward follow-through was false. When the general market bottoms, it frequently backs and fills (testing) near the lows made during the previous few weeks. It is usually more constructive if these pullbacks or tests hold up at least a little above the absolute intraday lows made recently in the market averages.

Follow the Leaders for Market Clues

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Follow the Leaders for Market Clues

After the daily general market averages, I would say the second most important indicator of primary changes in stock market direction is simply the way leading stocks act. After an advance in stocks for a couple of years or more, if the majority of the original price leaders top, you can be fairly sure the overall market is going to get into trouble. Of course, if you don't know how to recognize when the more aggressive market leaders are making tops and behaving in an abnormal fashion, this method of market analysis won't help you very much.

There are numerous indications of tops in individual stock leaders. Many of these securities will break out of their third or fourth price base formation on the way up. Most of these base structures will appear wider and looser in their price fluctuations and volatility and have definite faulty characteristics in their price patterns. A faulty base can best be recognized and analyzed by studying charts of a stock's daily or weekly price and volume history.

Some stocks will have climax tops with rapid price runups for two or three consecutive weeks. A few will have their first abnormal price break off the top and display an inability to rally more than a trivial amount from the lows of their correction. Still others will show a serious loss of upward momentum in their most recent quarterly earnings reports. The subject of when to sell individual stocks will be presented in great detail in the next two chapters.

Key Market Factors to Recognize and Use

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Key Market Factors to Recognize and Use

During a bear market, stocks frequently open strong early in the morning and close weak by the end of the day. During bull markets, stocks tend to open down and come back later in the day to close up strongly. (The market opens at 9:30 a.m. and closes at 4:00 p.m. New York time, 6:30 a.m. and 1:00 p.m. California time. But it is subject to periodic change.)

Catch a shift with this easy test: see if you show a profit on any of your last four or five purchases. If you haven't made a dime on any of them, you might be witnessing a negative shift in the overall market.

Additionally, if stop-loss orders are used and either placed on the stock exchange specialist's book at specific prices or mentally recorded and acted upon, the market that is starting to top out will mechanically force you, robotlike, out of many of your stocks. A stop-loss order instructs the specialist in the stock on the exchange floor that once the stock drops to your specified price, it then becomes a market order and
will be sold out on the next transaction.

In general, I think it is usually better to not enter stop-loss orders. Watch your stocks closely and know ahead of time the exact price at which you will immediately sell to cut a loss.

If, on the other hand, you can't watch your stocks closely or you are the vacillating-type investor who can't make decisions to sell and get out when you are losing, stop-loss orders might help protect you against your distance or indecisiveness.

If you use them, remember to cancel the stop-loss order if you change your mind and sell a stock before the stop-loss order is executed; otherwise, you could later accidentally sell a stock you no longer own. Such errors can cost you money.

One of the biggest faults investors have is that it takes time to reverse their positive views. If you sell and cut losses 7% or 8% below buying points, you will automatically be forced into selling as a general market correction starts to develop. This should make you begin to shift into a questioning, defensive line of thinking sooner.

A sophisticated investor who uses charts and understands market action will also find there are very few leading stocks that are correct to buy at a market-topping juncture. There is also a great tendency for laggard stocks to show strength at this stage. Seeing a number of sluggish or low-priced, lower-quality stocks becoming strong is a loud signal to the experienced market operator that the upward market move may be
near its end. Even turkeys can try to fly in a windstorm.

A peculiar tendency during a bear market is for certain leading stocks to resist the decline and hold up in price, creating the impression of true strength. This is almost always false and simply postpones the inevitable collapse. When they raid the house, they usually get everyone.

A 33% Drop Requires a 50% Rise to Break Even

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A 33% Drop Requires a 50% Rise to Break Even

The critical importance of recognizing the direction of the general market cannot be ignored, because a 33% loss in a portfolio of stocks requires a 50% gain just to recover to your break-even point. For example, if a $10,000 portfolio is allowed to decline to $6666 (a 33% decline), the portfolio has to rise $3333 (or 50%), just to get you even. Therefore, it is essential to try to preserve as much of the profit you have built up as possible rather than to ride most investments up and down through difficult cycles like many people do.

I generally have not had much problem recognizing and acting upon the early signs of bear markets, such as those in 1962, 1966, 1969, 1973, 1976, and 1981. However, between 1962 and 1981, I twice made the sad mistake of buying back too early. When you make a mistake in the stock market, the only sound thing to do is correct it. Pride doesn't pay.

Most typical bear markets (some aren't typical) tend to have three separate phases, or legs, of decline interrupted by a couple of rallies that last just long enough to convince investors to begin buying. In 1969 and 1974 these phony, drawn out rallies lasted 15 weeks. Many institutional investors love to "bottom fish." They will start buying stocks off the bottom and help make the rally convincing enough to draw you in. You will usually be better off staying on the sidelines in cash and avoiding short-term counterfeit rallies during the first few legs of a bear market.