Basics of Financial Market Behavior

Most people try to approach trading or investing by trying to "predict" the future price of stocks, commodities, currencies, or the market indices.

Different people have different methods. Some use fundamental analysis: looking at a company's health, balance sheets, earnings, the economy, etc. Others use technical analysis, trying to decipher trends and patterns in stock charts.

This is the wrong approach. It has been shown repeatedly for several decades that prices are not predictable, other than a general long term rising of the markets (due to the expansion of the country and world's economies. Of course, this long term tendency to rise has only been observed for the past couple hundred years, which means it is not guaranteed to happen forever.)

In any case, the unpredictability of the markets is well documented. One need only look at history. Money manager and traders, amateur and professional alike, have a track record that is no better than simply following an index fund. This has been shown time and time again. Read the book "A Random Walk Down Wall Street" for details.

If that's the case, one should just buy and hold an index fund, right?

Not a good idea either. If you buy an index fund at the "wrong time", it's entirely possible you would have to wait years or even decades to make any money. For example, if you had bought the Dow in 1929, you would have waited 25 years to break even. If you had bought New Zealand in 1987 you would have waited seven years.

Waiting a decade to see any return on your investment is hardly an investment.

What's the proper way to approach investing or trading? The proper way to tme your entries and exits according to the following basic tenet:

• When prices go up a LOT (relatively speaking) and FAST (relatively speaking), you can expect them to come down.
• When prices go down a LOT (relatively speaking) and FAST (relatively speaking), you can expect them to go UP.

It is that simple.

How far is far? How fast is fast? To answer this, it pays to compare long term stock charts with short term ones. A good guideline is something called the 50% retracement rule. Google for it. Pick up a book on it. Or look at my other pages on this website to learn more about it.

Here are the other rules to go by:

• Absolutely do not trade on news. News is often late, misleading, wrong, or agenda-driven. See my other posts on this website for details.
• If you are an active day trader, avoid trading important government reports. Do not enter a trade prior to the report, regardless of your opinion. Markets are very volatile during these times.
• Do not attempt to forecast peaks or bottoms. Your trading should only try to catch a portion of the major move, it doesn't matter whether you miss most of it, as long as you make a profit on some of it.

Skeptical? Sound too simple to work? I challenge you to compare your returns trading this method, with any other method you may choose.

Passive investors will benefit GREATLY by being only a LITTLE active in watching the markets and by identifying major moves. Look at daily stock charts often. Look at 10-year charts every once in a while. Identify major moves and the retracements of those moves. Identify vertical zones on stock charts where you can expect to make profits by trading these retracements. Identify probable areas to BUY. Identify probable areas to SELL and SELL SHORT.

Under no circumstances should you just "Buy and Hold" because that's what your investment advisor tells you.

You management of your money should follow these guidelines, whether you actively trade individual stocks or you trade portfolios or mutual funds. The principle is the same and applies to ALL financial markets.

* Article Source: Common Sense Trading.