Stock Market Learnings of History: for Make Benefit Glorious Long-Term Investment

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Today's post is an extremely important one for anyone who does not already know the information and historical precedents that are decribed here. The concept is also extremely simple and easily measured by the average investor with a stock chart and calculator. I will be explaining why it is not safe to be buying into the stock market now, and when it will be safe to buy back in the future.

This post is really for the benefit of the reader who fancies himself or herself as a long-term investor. They want to hold stocks for several years and make long-term capital gains, but would prefer not sit through horrendous bear markets or get suckered into buying stocks too early in a bear market and undergo enormous drawdowns on their investment, before (hopefully) realizing a profit several years down the road. Even with that long view in mind, since the markets are fractals, this concept applies to all degrees of trend, and can be used on short-term time frames as well. So are you ready.......?

Before you could be relatively certain that a bear market has bottomed, you need to see an advance that is greater in percentage terms than any advance/bear market rally during the bear market. Also the rate of this advance should typically exceed the rate of any other bear market rally in terms of (% advance) / (duration of advance). Also, in order to have a decent sample size, you need to have several rallies to compare to, say 4 or more failed rallies that make new bear market lows.

If you can grasp this concept, you will be ahead of the game by far. Certainly ahead of the talking heads on the TV.

The chart above is the Great Depression market crash of 1929-1932. It shows the percent advance from low to high of every major rally off of intermediate bear market lows. The red lines show the level at which price broke down to new lows. The green line shows the price level at which the % advance off the lows exceeded any prior advance in the bear market. The pink line shows the level at which the last major high before the bottom was exceeded. Now, say that there was an advance of 50% early in the bear market and now you see a 51% advance some time later. It is probably wise not to jump in right away because that rally could still fail. So typically you would take the largest advance of the bear market and require a rally 20% or 25% greater than that advance before entering the market again. That will give you an added degree of confirmation.

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For people who want a more recent example, this chart is of the Nasdaq bear market from 2000-2002. The same color scheme applies. Notice how the advance off the post Sept. 11 bottom slightly exceeded the largest prior advance in percentage terms only to fail several months later. That is why it is wise to require an advance that is 20% or so larger than the largest prior advance. Also, there were only 3 major rallies to compare to, when you really would want to see at least 4 intermediate rallies to get a better comparison. There are other more complex reasons (relating to complex wave patterns) for needing more than 3 rallies as well.

So how does this apply to the current market? There have been several failed rallies since the Oct. 2007 highs. The most recent advance from the Nov 21 low to the Jan 6 high was 27%. The prior largest rally was 24%. That is NOT enough greater than 24% to meet the 20% greater requirement. Also, the 24% advance took only 3 days, while it took 6 weeks for the recent 27% gain. That is not the explosive buying interest needed to confidently mark a bottom.

I could go on with further subtlties and detail about the time component, but careful study of the charts above should be enough for now to know to stay out, and what to look for to get back in the markets on a long-term basis.

Pete