The stock market has declined by 25% since the start of 2022. Apart from the odd stock like McKesson Corporation, we have largely stood aside from buying stocks through 2022 and for very good reasons. The market since the start of the year has been declining but has also displayed a mixture of bullish and bearish factors.
The first step to adding stocks into your portfolio is to establish market conditions. Look at it this way, if you are looking to start a business, you’d do your research first. And a big part of the research is to establish market conditions which might include the following questions:
- Is there a demand for the product?
- What is the demographic?
- Who are your competitors?
- How are their sales doing?
Based on your research, you then make an informed decision on whether it is worth pursuing the business or not. The riskier the business, the less chance of success but, potentially, the higher the reward.
Switching back to investing. When it comes to stocks, establishing market conditions is regularly overlooked. This is because many people, especially those who lack financial literacy, tend to think that stocks only go up and never down. A lack of awareness of the right approach also contributes to some regrettable mistakes when it comes to investing.
Now, let’s get you up to speed on how precisely to do this.
Stock Market Conditions In 2022
We use the S&P 500 Index as our gauge for market conditions and specifically the 200 simple moving average on the weekly (w200sma) and daily timeframe (d200sma). If you are new to investing or trading, the “200sma” does what the name suggests. It gives you the average price over 200 weeks or 200 days, depending on the timeframe.
If the price is above both the weekly and daily 200sma, the market overall is bullish, and we buy the strongest stocks. If the price is below both moving averages, then the market overall is bearish, and we short the weakest stocks. If they are out of alignment, we stand aside.
2022 has, up to now, been a stand-aside year. Price first broke below the d200sma in February and has continued to weaken. There was a temporary rally from June to August but the price yet again failed to move above the d200sma. The BIAS on the daily timeframe has been bearish this year.
However, on the weekly timeframe, price has remained above the w200sma this year but is that about to change? Is the price now attempting to break through the w200sma for the first time since the 2008 bear market?
If we see a convincing break and close below the w200sma (and further weakness), then the bearish market conditions will be confirmed.
The mistake many people make is buying cheap or undervalued stocks, made famous by Warren Buffett. Thinking that they’ve got a bargain, they are eagerly hoping for these stocks to skyrocket only to be disappointed with their continuous descent.
This goes back to what I said earlier about budding investors thinking that stocks will only go up. It is a common misunderstanding. Stocks can continue to drop and stay at these low prices for years on end. This classic mistake causes people to be lumbered with stocks they cannot get rid of and often for many years – and this means a portfolio that is in negative for eternity as well as missed opportunities shorting the market.
Bonus tip: It does not matter how much fundamental analysis and research you do to find the value in a stock. Ultimately, a stock is a piece of paper and is only worth the value someone is willing to pay for it.
Take PayPal, for instance. It is still a giant of a company doing insane numbers but its stock has dropped by 72% from $310 in 2021 to $80 this year, and it could keep on dropping regardless of what you think. Unfortunately, there will be many “Warren Buffett groupie” members lumbered with this stock hoping to get to just break even.
Go With The Tide
There is, of course, a better way. It is called trend following. It simply means that we go in the direction of the market as opposed to going against it. In other words, we stop trying to “be clever”. And when you take a moment to think about, it actually makes a lot of sense.
If you have the goal of having a healthy retirement pot, trend following is the best way to do it. We want to move through the bullish and bearish cycles of the market. And the groundwork needs to be done now if we want to see consistent growth year on year for the next 5 or 20 years (or more)! There is no time to waste, and every year counts.
The good news is that this classic mistake of going against the tide of the stock market can be easily fixed. Align yourself with the market instead of trying to outsmart or cheat it, and you will be handsomely rewarded.
Our Current Stance
We continue to remain on the sidelines, but if the price of the S&P 500 breaks and closes below the w200sma, we will switch our stance to bearish and start shorting the market.
We also have positions in the forex market. When money flows out of the stock market, it tends to flow into other asset classes. For now, the USD is trending and gaining momentum, and this is confirmed by the Dollar Index breaking out of a 7-year consolidation.
We are currently long on the USD/JPY, and short on the AUD/USD, EUR/USD and the GBP/USD. We will continue to hold and compound these positions, as well as adding further forex pairs. We will also continue to monitor the stock market and we are always prepared to act when the time is right.
