Listen to the Market

 | Jan 18, 2013 | 7:59 AM EST  | Comments
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The supreme art of war is to subdue the enemy without fighting. -- Sun Tzu, The Art of War

There are many ways to approach the stock market, but at the end of the day it all comes down to just two approaches. There is the technical/strategic approach and there is the fundamental. Those who use a technical/strategic approach rely primary on charts, momentum and price action. Those who use a fundamental approach rely primarily on valuation, news flow and macroeconomics.

The fundamentalists believe that stock prices are ultimately driven by earnings, interest rates and growth rates. They believe that the best way to produce superior results is to have insight into future events and their impact on the stock market before others. Quite often they will be fighting the market tide as they try to anticipate what will happen next. In their view the market is almost always wrong about what will happen to next.

The biggest problem with the fundamental approach is timing. There is just no way to know when the fundamental issues that the investor perceives will matter to the market. The market is notorious for ignoring what may seem like obvious negatives. It is often said the news doesn't matter until it matters. Having superior insight into future events has little value if you can't time the impact on the market.

To avoid this timing issue many market players, including me, use a technical/strategic approach to the market. We focus on the price action to tell us when all those fundamental issues might matter. We don't fight the price action, we embrace it. In this approach, coming up with reasons why the market is going to move this way or that way isn't that important. We just need to have a strategy in place so that we are ready to react when the inevitable shift in market fortunes occurs.

Our goal as technical/strategic traders is to conquer the market by accepting it and not fighting it.

The appeal of a fundamental approach to the market is quite understandable. People like to believe that the market is an exercise in logic. If this and that are true then this reaction will follow. It appeals to our intellect to believe that our insight into news and events will be rewarded. The business media is built almost completely on covering news and trying to predict future events. Who are we to see it isn't important when there is a whole industry that says that this is the way to approach the market?

Those of us who use a strategic/fundamental approach believe in the wisdom of the market. Future events are constantly being discounted each day and the market action reflects the collective wisdom of all investors. There may be missteps and random action in the short term but ultimately the market is the best predictor of future prices.

The current market environment is a good illustration of the differences in the two styles. The fundamentalists are focusing on reasons why this current rally cannot continue. They have been doing that for quite a while already and have been dead wrong. The technical/strategic traders are focused on the momentum and are staying with the market until it gives some indication that conditions are changing.

The technical/strategic trader can find a few things in the price action to worry about and many have raised some cash recently, but there is nothing yet to indicate that a major market turn is about to occur. When it does occur, the strategic trader will implement his or her strategy and adapt to the new conditions.

I enjoy listening to all the negative arguments against the market that are out there right now. So many are predicting doom and gloom at any moment and they have good reason for it. At some point, some of these predictions will be correct and they will bask in the glory of their foresight.

My strategy is to simply listen to the market and, when it tells me that there are problems that matter, I will take a more bearish stance. I'm not going to be celebrated as a great prognosticator, but I suspect my strategic approach will put more dollars in my pocket than a Miss-Cleo approach to stocks.

We have a flat open on the way and the bears are anxiously hoping that the big reverse finally kicks in. I've raised some cash lately, but I'm not betting on a collapse until the market action changes.

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