Trading the Trends

The greatest investors, traders, and speculators of all time have one thing in common. They understand the market does not always go up, they recognize the market moves in trends and cycles, and they capitalize on that knowledge.

Understanding how the stock market trends and cycles work is paramount to the success of every individual trader and investor. By recognizing the changes in trends as they are occurring, the trader and investor can protect and preserve their capital while profiting in any market environment.

                                                      1. Market History

Why would anyone want to Trade the Trends? Why bother with trend trading when all you have to do is buy-and-forget. The market has averaged a 10% per year return for the past 80 years. Investment firms consistently encourage the investor to just buy-and-hold. 

Buy and Hold

 A chart of the Dow Jones Industrial Average for the past 100 years

The preceding historical chart is very telling. Although for more than 100 years the market has advanced, there were long periods of time it did not. The investors who bought in 1929 waited 25 years just to break even. The market did not trade above the highs of 1929 until the mid 1950s. The investors who bought in 1964 waited 18 years to see a profit while watching their investments decline through numerous bear markets during that 18-year span. Obviously hoping they would someday get back to break even. What about investors who bought in 2000 or 2007? Who knows when they might realize some profit!  So buy-and-hold is not that simple.

Even though the overall movement of the market has been up for more than a century, our average lifespan is less than that, and our best earning and investing years are just a fraction of a century. Other very important facts regarding market history include:

1. Since 1900 there have been 29 bear markets. There has been a bear market on the average of every 3 ½ years with the average decline of 30%. Therefore, most every decline shown on the preceding chart is a result of a bear market. Yes, even in times of long-term market advances, there are bear markets.

2. When looking at the chart, every long-term advance is a Secular Bull Market, and every long-term sideways or decline is a Secular Bear Market. One has always followed the other.

3. The long-term advance from 1982 to 2000 is not a normal market move.the only other time in more than 100 years the market made such a dramatic advance was prior to the 1929 crash.

Market history also teaches us that major market corrections, and more specifically bear markets, happen more often than most people think. The problem is, most investors do not plan for the next one, anticipate its arrival, or remember the devastation of the last one. Pretending it won’t happen again does nothing to protect against it. And as the saying goes, “those who do not learn from history are bound to repeat it.” 

Bear markets:

Since 1900 there have been 29 bear markets. 

Average decline of 29% 

Lasted an average of 1.7 years (time in decline) 

Average time to return to break-even is another 1.9 years 

Bear Markets consumed 32% of that time

Getting back to break-even took another 44% of that time

Only 24% of that time was spent in net gain - Bull Market territory 

That sheds a whole new light on Trading the Trends. Since there are no risk-free investments, it makes absolutely no sense to put 100% of your investment dollars at risk 100% of the time when the market is only in net-gain territory 24% of the time.

The wise investor knows with 100% certainty he/she will be hit with a 30% or more loss if they hold through the next bear market, not to mention other severe market corrections that are just not so severe that they reach the 25% decline to be classified as a bear market. And we shouldn’t forget the 2001-2004 and 2007-2009 bear markets resulted in much more than the average 30% decline. Those buy-and-hold investors got closer to a 50% investment haircut. 

The long-term average gain in stocks (the S&P 500) since 1928 is just about 10.5% per year. However, during the bull-run from 2010 to 2025, the S&P 500 averaged a gain of approximately 14.3% per year (dividends reinvested). So let me ask a similar question: 

If the stock market averaged 14.3% per year for 15 years, what does it have to earn over the next 15 years to average 10.5% over the full 30 years?

If we do the simple calculation, the market has to average about 6.4% return per year over the next 20 years to come in at its long-term average.

To be true to form and return to the long-term trend, realistically the S&P 500 has only two options. Either decline back to the trend line or move sideways to eventually meet the long-term trend at some point in the future.

Sales people will also tell you to stay fully invested so you won’t miss the best days in the market. As you will learn in this book, missing the best days in the market is the least of your worries. So what if the market advances a few points today. What you really want to do is miss the worst days in the market, make money during the difficult market times, and protect your capital at all times. 

Whether you are investing or trading in stocks, mutual funds, index funds, or options, success comes by being on the right side of the market. 

                                        2. The Big Picture

For the most part, we are looking at the big picture. We really don’t care if the Dow Jones Industrials advance 50 points today or drop 60 points tomorrow. Those daily fluctuations can be aberrations, confusing, and pretty much inconsequential to the average investor and trader.

Yes, the market moves every day. It always has and always will. Sure, the talking heads and the news writers always try to affix a reason for the move, or explain in some misguided mindless way why the

market may have reacted to one thing or another. That’s noise and nothing but noise. 

The mistake many people make is ‘not seeing the forest for the trees.’

The Hidden Market

The financial news media is constantly scrambling to and fro for stories, making all sorts of attempts to present something on TV, or write the next article that will capture your attention. They consistently keep you informed, but most of the information is of a worthless nature. 

In order for a news story to be meaningful it must pass this one important test. 

                   “Is it fact, or is it opinion?”

An analyst’s opinion means nothing. A journalist’s opinion means even less. And even the opinion of a CEO means very little since there is always a vested interest in promoting his/her company. Opinions can and do change in the blink of an eye. Facts are the only things that matter. For instance, the Federal Reserve adjusts the interest rates up or down. The GDP shows a decline, or unemployment is on the rise. Facts that signal the economic cycle may be changing. Those are facts and cannot be changed or manipulated.

News can affect the overall market in the short term, but facts can affect it in the long term. Most every stock advances with the overall market.  Most every stock declines with the overall market. So when we

are looking at news articles and stories regarding one company or one market sector, we must decide if this bit of news really has any bearing on the big picture. We are always looking to be on the right side of the market. So we want to keep a close eye on the trend of the economy. The overall market, the bigger picture, is still the ball you want to keep your eye on. Remember, it doesn’t matter if your favorite company is turning profits out the wazzoo, if the general market heads into a major decline, then your stock will most likely follow suit. 

The big picture simply means that during an economic expansion, most companies are going to be doing well, if not great, and even most of the barely decent ones will also be doing something. However, during recessions, most companies will not do so well, contract with the economy, and the stock prices will reflect this contraction.

That is why during the late stages of expansion and the early stages of contraction you will notice money being moved to safer investments. For instance, in 2000 as the tech-bubble was reaching the top and about to burst, the tech-heavy NASDAQ advance slowed down and the Dow Industrials began a late advance.  What was really happening? Well, the dumb money was still buying into the internet bubble. But the smart money was selling to them and moving to safety. In other words, the

smart money was moving into stocks that hold their value better in bear markets and bad economic times. Companies that provide products like pharmaceuticals, staples, etc. that everyone must have regardless what the economy is doing.

The move to safety can also include large funds, not just the wise individuals. This is because according to the charter of a mutual fund, that fund must have a certain percentage of their investment dollars

invested in stocks, a certain percentage in cash, and a certain percentage in bonds, etc., (depending upon the fund’s charter, of course). 

Therefore, they cannot just sell out and go to cash. They must adhere to their percentage of investments. If they hold higher risk stock and the fund manager is smart enough to realize a market top or a bubble, then the stock portion of their portfolio is moved to a more defensive stance. Thus, the manager would attempt to limit the losses as best he/she can.