Trading and Market Behaviour

After observing the market behave in all its odd ways over a period of more than 15 years, I have gained a lot of experience and insight from when I started. So I’m ready to share and pursue this knowledge with you. This is about trading as a financial activity and how to navigate this with the understanding of market behavior.

In trading, you could make a profit regardless of the way the market move, be it going up (bull), going down (bear), or just going sideways (consolidation). This is not so for value investing. Let me illustrate what you need to do in the different market cycles,

  • In a bull cycle, it is great for an investor that is holding and selling when their investments have realized its value potential.
  • In a bear cycle, the investor will be salivating to buy good companies at a discount.
  • Consolidation phase after a bear cycle is where the temperament of a good and experienced investor will learn to just do nothing and hold, which is extremely important.

Now, the question and the challenge I experienced as a value investor was, what could an investor do in the other scenarios. Such as,

  • After the bull has topped, and you have liquidated most of your investments, and cannot find brilliant companies at a good price?
  • The market is bearish but the market was so overpriced that you just still cannot find companies that have come down far enough to justify the price.

Well, you definitely should not break your process and your own rules AS AN INVESTOR. You should stay out of the market in my opinion and experience. However, as said, it’s a different ball game for Traders.

5 Main Factors That Move The Market

To trade successfully, you need to know what makes the market move. The direction of the market is primarily determined by 5 main factors. They are:

  • Seasons & Cycles
  • Sector Rotation due to money flow
  • Interest Rates following monetary policies
  • Earnings Announcements and Results
  • News and Macroeconomic Data

These factors have the most significant impact on the way the market move either up, down or sideways. You will need to know them in order to analyze and monitor the market. To trade successfully, one needs to set up his trade to profit based on how the direction of the stock is expected to go.

Just imagine, in the analogy of a journey, you have to recognize the key elements as you will need to deal with it and to prepare for it. The environment is made up of the elements such as,

  • the weather (heat, cold, rain, snow);
  • the water (rivers, lakes, sea); and
  • the terrain (rocks, mud, vegetation).

Similarly, in trading, the 5 factors above needs to be understood clearly in terms of what they represent, how they work, how they behave, what they will do to the market. Think Market = Environment, it is NOT within your control, and you must accept it. However, you can try to understand it so that you can deal with it to come out profitable. This is what I will share next, how to deal with it? What are the key knowledge and skills that give you the ability to become a successful trader? Now, these are within your control.

Comparing Investing and Trading in detail

Starting with these 2 classic definitions that I abide,

One – Benjamin Graham, along with David Dodd, attempted a precise definition of investing and speculation in their seminal work Security Analysis (1934), “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

Two – In Reminiscences of a Stock Operator, Jesse Livermore offered, “The speculator is not an investor. His object is not to secure a steady return on his money at a good rate of interest, but to profit by either a rise or a fall in the price of whatever he may be speculating in.”

The KEY DIFFERENCE is this,

One – Investing is passively betting on the long-term future of the Economy based on:

  • Risk Aversion
  • Capital Management
  • Defensive Planning

Two – Trading is actively betting on the near-term future of the Economy based on:

  • Risk Reduction
  • Capital Protection
  • Defensive Planning

So after knowing the landscape and the elements that you need to deal with, how well you do as a trader will depend on how you plan defensively your trade by considering how to reduce risks and protect your capital in any given environment. If you are a seasoned adventurer (think Bear Grylls), who can adapt and successfully travel in any kind of element if you plan well and do the same in terms of reducing the risks and conserving resources.

Bringing It All Together When Trading

Let me conclude by sharing how you can go about to reduce risk, protect your capital and plan a trade defensively.

How does one reduce risk in the market?  

You will have to know the following,

  • Fundamental Analysis
  • Macroeconomics
  • Technical Analysis
  • Hedging

How does one manage capital when trading in the market? 

  • By managing:
    • Budget
    • Leverage
    • Gearing
  • By exercising proper:
    • Cost Averaging
    • Profit Taking
    • Loss Control

How does one plan defensively? 

  • By considering the following 5 factors to inform you of how the market is behaving or going to behave:
    • Seasons & Cycles
    • Sector Rotation due to money flow
    • Interest Rates following monetary policies
    • Earnings
    • News and Macroeconomic Data
  • By carefully planning and managing your positions through the use of:
    • Price Targets
    • Stop Loss Targets
    • Time Targets

All these will be elaborated in greater detail. Thanks for reading this long but necessary introduction to what I learned in trading. It’s always a ton of fun to put this down and share this. So stick around and remember to check out my blog regularly for new content. Meanwhile, go check out my tool for scanning stocks and analyzing the market data >> Trader Personal Assistant.

Leave a Reply

Your email address will not be published. Required fields are marked *