Welcome to the new Cracked.Market University educational series. Look for new articles every Monday and Wednesday.
Many traders approach the market by trying to predict the outcome of an event and profit the market’s expected reaction. If the Fed raises rates, then the market will respond this way. If unemployment misses expectations, the market will move that way. Cause-and-effect analysis works well in everyday life it is natural to bring this line of thinking to the market. Unfortunately this method fails to account for how markets work and this omission explains why so many people lose money.
Traders often predict the outcome of a market moving event correctly, unfortunately they are not as good at figuring out the market’s reaction. This leads to the popular misconception the market is “fixed” and “rigged”. This couldn’t be further from the truth and I will cover this fallacy in another blog post. In the meantime just take my word for it the market is an equal opportunity humiliator and does a fair and equitable job screwing over both retail and institutional investors. When you lose money, it isn’t because some cunning market villain stole your money, it’s because your analysis is missing key ingredients.
In my two decades of trading, far and away the most effective tool I use in identifying market’s next move is studying what it is NOT doing. Almost everyone obsesses over what the market is doing and tries to to fit these moves into their narratives, whether that is fundamental, technical, or a hybrid of the two.
The problem is looking at what the market is doing inevitably leads us to thinking about what it “should” be doing. When the market doesn’t do what we think it should be doing, rather than admit we are missing something, our natural instinct is to argue with the it. This response is incredibly counterproductive and leads to more lost money than every other mistake traders make.
Take the current situation with North Korea. This is obviously a bearish development and there are grave consequences for everyone involved if this situation escalates beyond words. Despite these ominous warning signs, the market continues to hover near all-time highs. This leads many people claim the market is complacent, stupid, and worse. Common sense tells us the market should have sold off dramatically on these dire headlines. But we didn’t. That mean either the market is wrong, or god forbid, we are wrong. We couldn’t possibly be wrong, so obviously the market is wrong.
Rather than acknowledge the market’s strength, these critics double down and claim it will only be time before prices crash and they are proven right. The problem is these traders are missing the incredibly powerful signal the market is giving us. This market is not selling off, not because it is stupid, but because it is unbelievably resilient and strong. There are few things more bullish than a market that refuses to go down on bad news. Everyone who is spending all their energy arguing with this market is about to get run over.
If this market was fragile and vulnerable, it would have crashed a long time ago. Rather than argue with it, we should acknowledge it. Better yet, let’s profit from it! A market that refuses to down will eventually go up.
The same thing happens on the opposite side. A market that fails to go up on good news is a clear warning of potential exhaustion. A recent example is AMZN spiking on the acquisition of WFM. Since then the stock is down 13% and it definitely looks like it is struggling to find new buyers.
Asking what is the market is not doing gives a trader great insight into which direction a stock is inclined to go. A market that refuses to go down on bad news has a lot of upside potential in it. A stock that fails to go higher despite all the praise it is getting is a clear sign new buyers are scarce and at the very least it needs to rest and consolidate recent gains.
I have a large assortment of tools and techniques I use to evaluate the market, but this is far and away the easiest, most powerful, and most profitable tool I use.
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Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.