Click here to take a look back at Rule#1- Buy New Lows, Not New Highs!
Now here’s rule # 2 – Buy After Pullbacks, Not After Rallies!
We’ve all watched CNBC or Fox Business News or Bloomberg TV and seen how emotional the reporters and the analysts become after the market rises sharply for a few days or drops hard for a few days.
After the market has risen, everyone is jumping up and down telling you how good things are and why prices are likely going higher. After a hard drop, the doomsayers come in repeating over and over again why the market dropped and why it will likely continue to drop.
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As most of us have seen, these people are usually wrong. Why? Because they are only repeating what the market already knows. And the market has already factored in much the good news (that’s why it has risen) and it has already factored in much of the bad news (including the potential for future bad news).
This has been the way markets have worked for decades and in our opinion, they will likely work like this for decades to come.
How do you profit from this information? By not buying the market or a stock right after its risen a number of days in a row, and not selling (or shorting) a stock after it has dropped a number of days in a row.
Here are some statistics to guide you. Since 1989, after the S&P 500 index has dropped three days in a row, it has risen nearly 4 times it’s average weekly gain over the next five trading days. And, after the S&P 500 has risen 3 days in a row, it has made nearly zero net gains over the next five trading days. And the same price behavior has been seen in the NASDAQ 100 index.
In conclusion, buy the market after it’s dropped, not after it’s risen!
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Read the next installment in our series, TradingMarkets 10 Trading Rules: #3 – Buy Stocks Above Their 200-day Moving Average!
David Penn is Editor in Chief at TradingMarkets.com.