Note: A version of this article appeared on the Trading Markets site, 10/2/06.
My advice for new traders is to question, question, question everything they read and hear about markets. Many times, common wisdom is uncommonly misleading.
As we've moved toward bull market highs in the large cap indices, for example, we've heard that the 'trend' is up and that long positions are therefore warranted.
Well, let's do a simple analysis by breaking the market since 2004 (N = 682 trading days) into three categories: 1) occasions in which SPY is up on the day, up on the week (five day period), and up on the month (20 day period); 2) mixed occasions in which SPY is a combination of up/down over the three periods; 3) occasions in which SPY is down on the day, down on the week, and down on the month.
When we've been up over all three time frames (N = 192), the next ten days in SPY have averaged a loss of -.20% (99 up, 93 down). When we've been mixed over the time frames (N = 374), the next ten days in SPY have averaged a gain of .28% (223 up, 151 down). When, however, we've been down on all three time frames, the next ten days in SPY have averaged a gain of .95% (77 up, 40 down).
The common wisdom - and the common human tendency - to buy when the market is strong and sell when it's weak would have lost a trader a significant amount of money.
So, to paraphrase literary critic Dorothy Parker, here's my advice: Next time a market analyst/guru waxes poetic about buying the market because the market is strong, don't toss his advice aside lightly.
Hurl it with great force.
Brett N. Steenbarger, Ph.D.