Imagine a scenario where the market drops 20 percent this year. Sounds drastic, but in fact it did just that in 2001, and again 2002, and once again in 2008. Back then many investors used the majority of the next big move up just getting back to even instead of making money. (See my article, “Two Beers, A Napkin and A 401k”).
But suppose in this scenario you were able to avoid the “big hit” and experience a flat return or just a minuscule loss. Wouldn’t you agree that you’d be in good shape going into the next move up in the market?
Now back in the 1980s and 1990s, absorbing just a small loss in a year where the market dropped 20 percent would be called “significant performance” relative to the rest of the market. This is because folks in the market back then were more interested in “relative returns” and not “absolute returns.”
The reason so many were interested in relative returns was simply because throughout the ’80s and ’90s, we were on a tear in a secular bull market. Every pullback was simply a great buying opportunity. You were labeled a hero if the market dropped 25 percent in one year and you only lost 10 percent.
At my firm, Balser Wealth Management, we’re not that interested in relative returns, and you shouldn’t be either. What we are interested in is absolute returns.
The research method I use, called point and figure technical analysis, is not perfect. But is does an ample job of letting me know when supply bypasses demand. This holds true whether we’re looking at a mutual fund, an individual stock, a stock sector or the market as a whole. Each and every time supply passes demand, lower prices are certain to follow. Subsequently, you should take steps to protect your investment and/or retirement dollars at that time.
You see, losing money effects your returns for many years, not just one year. That’s because if you have a year where you lose 20 percent, you’ll need to make 25 percent just to get back to where you started. So it’s really important that you do your very best to avoid big losses in your account, whether that account is your regular brokerage account, your 401k at work or some other retirement plan.
So what should you do to avoid big losses when the market starts falling?
Well, the market is not falling now (as I write this article), but it also wasn’t raining when Noah built the Ark.
I just like to be to be prepared for the worst, rather than make emotional, snap decisions about investments — those are almost always bad decisions.
Wouldn’t it be better to have a clear indication of the trend of your investments before you make a decision to sell? Hopefully you won’t need to take defensive steps right away. But eventually, you’ll need to use some of these action steps.
First, there are times to play “offense” in the market and times to play “defense.” Playing offense,meaning to stay invested in the market 100 percent of the time, is just not a game plan. Playing offense 100 percent of the time, meaning never selling, means you’ll ride the roller coaster all the way to the top and then all the way down.
Why go through the harrowing roller coaster ride when we have tools that tell us, very clearly, when supply starts to control the market? Anything with too much supply sees a price decline. That’s not theory, or even a fact. It’s a basic economic principle.
Although I can’t guarantee you’ll be getting out at the very top, I have clear signals when demand has dried up and supply begins to take control.
Remember, the main objective when we play defense is to sidestep severe losses in your portfolio and stay in the game.
So, step one is to know whether we’re on offense or defense. The way I know this is by monitoring the bullish percent charts. These insightful charts simply show the percentage of stocks on buy signals. If only 40 percent of stocks are on buy signals, we know there are lots of stocks around that haven’t yet given buy signals. At 40 percent there’s plenty of room on the upside.
But say 80 percent of all stocks are on buy signals. Then there aren’t many stocks left to produce buy signals, right? So the odds of the market moving much higher become fairly slim.
That means almost all stocks (80 percent of all stocks) are now on buy signals. At that point, there’s only a few left that haven’t given buy signals. So anyone that wanted to get into the market is most likely already in. At this point, demand is beginning to dry up.
What we want to watch for is when the bullish percentage starts falling off from those levels, because that signals that supply is now starting to come back into the picture.
So where are we today?
Basically everything’s calm right now. The New York Stock Exchange Bullish Percent, our main indicator, is on offense with good field position. This means that there is possibly more room for the market to run. But we’ll certainly hit rough waters sometime in the future, and we’ll want to have a game plan because there’ll be no time for deliberating, only time for action.