Picking tops and bottoms in the market is really hard. Some people claim they can do it and we’ll let them. It’s those types of people who help create the arbitrage between the aware and the unaware.
Markets are rarely ever putting in a top or a bottom. Most of the time they’re just somewhere in the middle. For years I’ve told my friend Josh that his best blog post ever was one from 2012 which he titled, “Tops, Bottoms and Middles”.
My friend JC likes to say picking tops and bottoms is the most expensive job on Wall Street.
A lot of the media’s time and attention is spent discussing whether or not something is bottoming (housing, stocks, consumer confidence, ratings, etc) or topping (tech stocks, valuations, bond prices, sentiment). It’s great conversation but not helpful.
Because most of the time things are not bottoming or topping. They are middle-ing. They are churning or they are trending. Most of the time, there is no inflection point at hand – these are rare occurrences. So to focus on them to such a great degree is probably a distraction and definitely a waste of time. And energy and emotion.
Think about the middle.
This post probably took him 5 minutes to write and publish to the world. He’s good like that. But I’m not sure that he’s ever put it so perfectly.
I think about this constantly. Markets trend. That’s just the way it is.
We could spend all day looking for tops and bottoms, or we can use our tools to identify trends and err in that direction.
A good example recently is identifying the trend in 2019 for US stocks. The weight-of-the-evidence suggested the risk was to the upside tactically, regardless of how bearish we were throughout the 4th quarter. In fact, every single stock trade we’ve put on this year has been from the long side. There have been about 40 buy ideas in total between U.S. and Canada. We didn’t know that stocks would go up. It was just the direction in which we wanted to err. We wanted the probabilities on our side, regardless of the outcome. It’s a process.
This is the chart that I had been pounding the table about to our subscribers throughout both November and December. It represents the percentage of NYSE stocks above the 200 day moving average. The buy signal is not when the percentage falls below a certain level. It is well after it reverses and then gets back above that level that we want to be involved from the long side. My level is 15%. Some other smart people I know wait until it gets back above 20%:
Either way, the point here is that we’re not trying to pick bottoms. We’re trying to get the chunks in the middle. I would rather buy stocks while they’re already going up, or selling them when they’re already going down. In the case of this chart above, it is the perfect example of NOT trying to pick a bottom, but instead focusing on the chunks well after the bottom has already been put in. Let the suckers try and catch a falling knife.
The old joke goes like this:
A Technical Analyst and a Fundamental Analyst are chatting about the markets in the kitchen.
Accidentally one of them knocks a kitchen knife off the table landing right in the fundamental analyst’s foot!
The fundamental analyst yells at the technician, asking him why he didn’t catch the knife?
“You know Technicians don’t catch falling knives!” , the technician responded.
He in turn asks the fundamental analyst why he didn’t move his foot out of the way?
The Fundamental analyst responds, “ I didn’t think it could go that low”.
The lesson is that we want to let it bounce and give us a point of reference that we can err against. Last month was a great example of that and one we want to point to in the future as a lesson. Many of you started off the year very well and kudos to you. Others certainly struggled. For both the winners and the losers, this is still a good lesson. We shouldn’t just learn from our mistakes, we should also learn from our successes. It goes both ways. The idea is just to keep learning.
So to recap, moving in the direction of the underlying trend increases the probabilities of success. It doesn’t mean we’ll always be right. In fact, we know that we won’t. We always want to assume that we’re wrong. It’s not how much we can potentially make that matters most, it’s how much can we possibly lose? What is the worst case scenario?
First we identify the risk, then we calculate the potential reward and make sure that we’re erring in the direction of the underlying trend. We’re not picking tops and bottoms. That’s a fools game. We’re focused on the middles.