Before I proceed into what is a must skill to have in your repertoire as a private investor, I would like to extend our well wishes to you all from us all here at Sublime Trading. We hope you and your loved ones remain strong and healthy during these testing times.
We can certainly assume that life is likely to be very different when we emerge from this, which we will, and part of that must be taking the time now to understand how to take full advantage of the opportunities available to you when it comes to taking complete control of your finances.
Financial literacy is the goal to not only bulletproof your investments in down periods but to grow your wealth in the recovery phase and beyond.
Remember, COVID-19 is just a moment in time. The markets will be here well after this has come and gone and you want to be in a position to grow your wealth consistently year in year out no matter what life throws at you.
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There is a very good chance that you are now familiar with terms such as ‘a market crash’ and ‘a bear market’ if you were not before but what you really have to be asking yourself is:
How much of this do I need to fear?
How can I actually physically see what a bear market is?
How can I first protect my investments?
How do I position myself correctly through COVID-19 and beyond?
So let’s start answering these questions one by one.
Any global event - financial, political, economical, health - as seen through mainstream media will often be portrayed as if the sky is falling down and we are about to enter a post-apocalyptic Mad Max type Earth.
I would like to think that human progress has come far enough to prevent that ever happening.
So the simple answer is fear is eliminated through knowledge and with this time on your hands, your goal is to get as clued up and as knowledgeable as possible to protect yourself, your family and your future wealth from the fear that is often spread through our television boxes.
How do you do this?
The answer is learning to read charts, known in the investing and trading space as technical analysis (TA), and then being aware and understanding how to correctly and safely use powerful investment vehicles open to you such as spread betting and CFD broker accounts which will allow you to buy or go long to profit in a bull market and sell or go short to profit in a bear market.
‘Shorting’ is a concept that many are unfamiliar with or may have heard of due to movies such as The Big Short’ but extremely few people understand the mechanics of what is happening in a bear market and how and when to start building a portfolio to short a market.
Knowing this will completely eliminate any fear you have as you are tooled up to profit from when a market is going up and when it is going down.
There are numerous examples in the market when shorting would have made you excellent profit:
The bear markets of 2000 and 2008 were extremely profitable which we will be looking at as we proceed through this article.
Oil handed out excellent profit in 2014 when it fell from $100 to $50.
Even our own Great British Pound has taken a beating since 2007 handing out profit to short investors.
In simple terms, this is how shorting works.
You drop me at the airport in my car.
I tell you to keep my car while I am away for 3 months.
You say fine with a big smile on your face.
When I leave, you go to the nearest showroom and sell it for £100k.
I come back 3 months later and want my car back.
You say fine with a smile on your face.
You go back to the car showroom and my car is still there.
3 months later, the value has dropped to £70k.
You buy the car back and give me my car.
You keep the £30k with a bigger smile on your face.
So you borrowed my car, sold it and bought it back and kept the difference.
In spread betting and CFD accounts, effectively you are borrowing the asset off the broker, selling it and then buying it back at a cheaper price and pocketing the difference.
So this takes us to the next stage...
By looking at charts and using technical analysis, you can easily separate the person watching the news from the investor inside you that is managing the family portfolio. This is essential for long-term wealth generation as the charts tell you exactly what is happening as to what you are being told is happening through media channels.
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I like to make sure I am up-to-date with global events just so I can get involved in conversations when around a dinner table but I block all of that out when it comes to my investment decisions. The charts tell me all I need to know.
So here is an Investment 101 guide on how to actually recognise both a bull market and a bear market.
The stock market index of a country is a great way to engage in the general health of an economy. If the stock market is bullish then people are spending and buying. If the stock market is bearish, there is uncertainty and fear.
There is a saying that ‘If America sneezes the rest of the world catches a cold’. What this means is that what happens in the US tends to have a huge impact on the rest of the world and so looking at the 3 major US indices is the perfect indicator of the market conditions we are dealing with.
The 3 main US indices are the S&P 500, the Dow Jones 30 and the Nasdaq 100. These indices are an average of a group of 500, 30 and 100 respectively of the biggest companies in the US. These indices will move in unison so when the economy is healthy these will all be bullish together and when the economy is hit, they will be bearish together.
The S&P 500 is generally taken as the primary indicator out of 3 so that will be the focus of this article moving forward.
It is important to note that here at Sublime Trading, we do not trade the indices. As they are an average, we use them to gauge in overall market conditions. Once they have dictated a clear bullish or bearish market, we then narrow down to the best performing individual stocks as found through our intricate scanning process.
Ultimately, we want to invest in the stocks doing better than the average in a bull market and weakening faster than the average in a bear market.
Before you start shooting off looking for a scanner, we have done all the hard work for you with our weekly stocks newsletter that covers the top-performing stocks in the UK and US market saving you £1000s in subscription costs and hours daily and weekly looking for them yourself.
Now, before we go any further, let’s break down technical analysis a little further into 3 parts:
What are candlesticks?
What timeframes are best to use?
What are the 200 simple moving average and the 50 simple moving average?
Charts ultimately represent price movement for a stock, commodity or currency pair. Price can be represented in a number of ways but the most beneficial way is using candlesticks.
Candlesticks originated from Japan and visually are the best way to represent price as you can easily see the open, the close, the high and the low of price.
If the candlestick is green the buyers have been in control.
If the candlestick is red the sellers have been in control.
It is nothing more than that. The skill of smart investing, however, is not getting bogged down in individual candlesticks and instead being able to ‘capture’ many candlesticks over many months either to the upside (a bull market) or to the downside (a bear market). This then leads us onto timeframes.
With the tech age, we now have access to a plethora of online charting packages, some good some not so good. What this means is that you can choose ‘a timeframe’ to view price data coming through on and see these candlesticks being formed in real-time.
With software, this means that you can see price data in the form of the open, the low, the high and the low coming through even as low as per second or per minute.
However, as private investors, the best timeframes to use are the higher timeframes in the form of the monthly, weekly and daily timeframes.
The huge advantage to these higher timeframes is that we are not concerned with what is happening second to second, minute to minute or hour to hour, which is often just a lot of noise, but day to day, week to week and month to month which is where all the noise gets absorbed and instead we get a much clearer picture of the strength or weakness of the asset.
By looking at the higher timeframes, we can see:
If the candlesticks are going up over weeks and month we are in a bull market or bull trend.
If the candlesticks are going down over weeks and months we are in a bear market or bear trend.
If the candlesticks are oscillating sideways we are in a consolidation market.
By understanding the above structure of an asset we can respectively:
Go long or buy to make profit in a bull market.
Go short or sell to make profit in a bear market.
We can stand aside, apply patience and protect our money in a sideways market, a much misunderstood and under-appreciated skill of a good investor.
To be able to understand further the 3 different environments mentioned above, we now need to understand moving averages.
A simple moving average (SMA) does exactly what the name suggests which is give the moving average over 200 hours/days/weeks etc and 50 hours/days/weeks etc depending on which timeframe you choose to use. They are then represented as lines on the charts.
As smart investors, we have already acknowledged that the daily, weekly and monthly timeframes are the best to use to get a clear picture of market conditions.
The 200sma and the 50sma are best used on the weekly and daily timeframe to engage in market conditions.
As a slight digression, the monthly timeframe is simply too slow of a timeframe to use moving averages on and is best used for other key purposes such as:
Looking at the trend history of an asset. If it has trended well in the past it is likely to trend well in the future.
Analysing where current price action is in relation to last year’s high and low.
Identifying key levels where the market has reversed from up to down, known as resistance levels and down to up, known as support levels.
Now moving back to moving averages, why the 200sma I hear you ask? Old school traders used to have to draw charts by hand and so were very selective with the information they put on their charts.
The 200sma was a proven indicator of the long-term trend so if price was:
Above the 200sma, price would have a bullish bias.
Below the 200sma, price would have a bearish bias.
The bias would then determine if you would look for long/buy opportunities or sell/short opportunities. You do not EVER go against the bias and this is where discipline and patience come in.
Institutions still use this logic today. This is a proven method so if it ain’t broke don’t fix it. Keep it simple and use what works and will always work as opposed to trying to reinvent the wheel which most try and do and fail.
Moving on, the 50sma is a proven indicator of support and resistance. In simple terms:
A support level is a ‘floor’ that price bounces off to create new highs.
A resistance level is a ‘ceiling’ that price bounces off to create new lows.
Now knowing what timeframes to use and what moving averages we use, we can put this all together to get an idea of what market conditions we are dealing with. Ultimately, as investors, we are looking for high-probability environments where we have more chance of making profit over weeks and months and minimise losses.
The magic word we are looking for is alignment between the weekly and the daily timeframes.
For bullish alignment, we want price to be:
Above the 200sma on the weekly timeframe.
Above the 50sma on the weekly timeframe.
Above the 200sma on the daily timeframe.
Above the 50sma on the daily timeframe.
For bearish alignment, we want the opposite and want price to be:
Below the 200sma on the weekly timeframe.
Below the 50sma on the weekly timeframe.
Below the 200sma on the daily timeframe.
Below the 50sma on the daily timeframe.
How I like to explain this is that the weekly timeframe is big sister and the daily timeframe is little sister. Whatever big sister is doing we want little sister to be following.
If the sisters are aligned we are entering a high-probability environment where we can start looking to place positions. If not, then we stand aside and protect our money until they are.
With the daily timeframe being a faster moving timeframe than the weekly timeframe, the daily timeframe will tend to move through moving averages first and then weekly catches up.
As already mentioned, applying patience and waiting for timeframes to align to offer high-probability environments is a key skill to a good investor.
In 2000, we saw the tech bubble burst and in 2008 we saw the financial meltdown. Let’s look at both periods closer applying the timeframe and moving average logic outlined above to the S&P 500:
To answer this, I have introduced the monthly timeframe below. As mentioned earlier, the monthly timeframe is perfect to engage in the history of an asset to see how well it has trended in the past. If an asset has trended well in the past then it is likely to trend well in the future.
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Looking at the monthly timeframe above, I have highlighted the cycles of the stock market. I have also highlighted the high of March 2000 which acted as resistance in October 2007 and the low of October 2002 which acted as support in March 2009.
The tech bull burst in March 2000 and the bear market lasted 2 years and 7 months until October 2002.
The bull revival started in October 2002 and lasted 5 years until October 2007 reversing into a bear market at the high of March 2000.
The financial meltdown began at this resistance level and lasted until 1 year and 4 months until March 2009 when the bulls took over and went on to create what has been the longest bull run in history.
Now by understanding these key turning points, known as resistance and support levels, good investors would have built portfolios between these cycles and then executed their exit management strategy, and hence tight protecting their investments, when price reached levels where the market had a chance of reversing.
Then once the market had reversed, they would have reversed their bias and built a portfolio in the opposite direction.
So before 2000, good investors would have been long-only. When the market started reversing in 2000, good investors would have exited from their long positions for profit and once the market had confirmed a bear market in 2000, they would have shorted the market until 2002.
When the market started reversing in 2002, good investors would have exited from their short positions for profit and once the market had confirmed a bull market, they would have reverted back to buying or going long on stocks until 2008.
As price had reached the high of 2000, good investors would have applied caution here and executed their exit management strategy which would have included tightening stop-losses to lock in as much profit as possible as the market had a high chance of reversing to the downside which it did.
In 2007, good investors would have been stopped out of their long positions for profit and once the market had confirmed a bear market in 2008, they would have shorted the market until 2009.
Similarly, as price had reached the low of 2002, good investors would have applied caution here and executed their exit management strategy which would have included tightening stop-losses to lock in as much profit as possible as the market had a high chance of reversing to the upside which it did.
Since 2009, once a bull market had confirmed itself, good investors would only have been long with stocks going on to create unprecedented new highs which included smashing through the highs of 2000 and 2008.
So the answer to how to protect your investments is not moving with the cycles of the market but also understanding where these reversals are likely to occur based on past history and support and resistance levels.
As I have already said, applying patience to wait for environments where you have more chance of making a profit than a loss is essential to consistent growth.
By looking at the charts, you avoid scenarios where you get in too early and are faced with losses that could have been avoided by applying patience.
Back in 2018, there was a bearish reversal in the market when, if you were listening to the news, terms like ‘recession’ and ‘crash’ were being loosely thrown about.
To the untrained brain, this fear-mongering would have only caused fear and confusion but to the trained brain, this would have been nothing more than a short-term ‘correction’ in the market.
At this time, price broke through the daily 200sma but found support at the weekly 200sma before bouncing off it and resuming the bullish trend. Looking at the charts would have helped manage your bullish positions as well as ensure you avoid losses by not getting in too early into bearish positions as price did not break below the weekly 200sma.
Remember, we want to see price trading below the daily and the weekly 200sma for a bearish market and vice versa for a bullish market.
This all goes back to my original point mentioned at the start around eliminating fear, blocking out the noise and getting a very clear picture of what is really happening in the market as looking at the charts tells you absolutely everything you need to know.
Simple. Patterns repeat again and again and again and by applying the above logic of higher timeframes and moving averages, we move through the cycles of the market profiting from bull markets and bear markets.
At the time of writing this article, March 29th 2020, due to the fear around COVID-19, the rapid drop in price which started in February took price below the weekly 200sma and 50sma and the daily 200sma and the 50sma suggesting that market conditions are bearish and that we should be shorting the market...
Not just yet! Here’s why. Remember, earlier I said that the monthly timeframe was also good for analysing where current price action is in relation to last year’s high and low.
Well looking at the month of March, we can see that price was trading below the low of 2019 earlier in the month but the bulls came in strong towards the end of the month and have pushed price back above the low of 2019 which is now support.
To start considering short positions, not only do we want price:
Below the weekly 200sma and the weekly 50sma
Below the daily 200sma and the weekly 50sma
But we also want to see price:
Break AND close below the low of the previous year by the end of the month.
Once all 3 factors have been met, then we can start considering short positions as price will have then dictated a high-probability bearish environment.
At the time of writing this, price had only met the first 2 criteria and not the third and so by applying patience we have avoided getting in too early and be faced with losses. Smart!
Certainly not now and you do not want to fall for the amateur rhetoric that now is the right time to buy stocks as they are ‘cheap’.
Looking at the charts above, it is clear that there is the possibility for stocks to keep dropping and if that is the case, you want to be shorting the market and not buying stocks, particularly if we get the timeframe alignment as highlighted above across the daily, weekly and monthly timeframes.
At the very earliest, to start buying stocks, we want to see price on the S&P 500:
Above the weekly 200sma and above the weekly 50sma
Above the daily 200sma and above the daily 50sma
We do not necessarily need to be waiting for the S&P 500 to be plotting new all-time highs as the strongest performing stocks that are performing better than the average will already be plotting new all-time highs and as mentioned at the start, it is stocks we invest in and not the indices.
The stock market is one market, there are two other giants of a market in the form of the commodities and currency markets that must make up your global watchlist.
There is a natural flow of money from market to market so when money leaves stocks, it tends to flow into other markets causing lucrative medium to long-term trends.
There is a very real chance that the stock market does not dictate a bullish or a bearish market and remains between the high and the low of 2019 for the foreseeable future in which case it is even more important to focus across asset classes and take advantage of emerging trends elsewhere.
Remember, attachments such as having a ‘favourite’ are extremely unhealthy in investing. An attachment should only last for as long as any particular asset is paying you.
Once it stops paying you, say thank you and move on to the next trending asset whether it be a stock, commodity or a currency pair.
The name of the game is to make profit and not pursue and keep unhealthy love affairs with an asset that cares very little about your emotional ties.
At the time of writing this, here are some emerging trends in commodities and currencies. The first sign we look for here at Sublime trading for a new trend is price to be trading above the high of last year for bullish trends or below the low of last year for bearish trends which, as explained above, we look for on the monthly timeframe.
So there you go guys, how to establish bullish and bearish market conditions that will help block out the noise and confusion that is caused by mainstream media and social media channels and instead, establish the exact market conditions you are dealing with to better protect and grow your investment portfolio during COVID-19 and beyond.
To build further on this article, I invite you to register for a document that we created on how to start preparing NOW for the opportunities that COVID-19 is presenting.
This is a live document that will be regularly updated with the most relevant information on how to navigate through COVID-19 and beyond.
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