Should Market Conditions Affect The Way You Trade? 

In the last few posts I delved into the topics of personality, risk management, position sizing, different styles of analysis such as fundamental and technical. Here I want to show the important final piece which I do believe should be part of every successful trader’s tool box, current market conditions analysis.

For those who know my story, when I began all those years ago, I started as a pure ‘Warren Buffett’ type value investor and hence was only ever interested in what you would call ‘bottom up analysis’ of a company I liked and was looking at investing into. I would look at its current financial position, its earnings, its prospects, its competition, and finally its valuation. If it was good enough and cheap enough, I would buy without any further consideration.

Looking back, how naïve I was. I was no Warren Buffett who understood the stock’s industry dynamics inside and out.

Years later when I became enamoured with technical analysis and almost completely let go of value investing, I looked at nothing but the charts and the price action of the stock. Was it trending up or down, where is support and resistance, was there a head and shoulders pattern etc etc.

Then in the last five plus years, I became very market driven and hence really studied where current market conditions are and would form a view based on economic data I trawled through. I swung 180 degrees from being ‘bottom up’ to ‘top down’ analysis.

Although I finally came to my senses and decided that all three combined worked best, it was this segregation of each and studying them and implementing trading strategies within each camp separately that allowed me to discover how important each were on its own and concluded that ignoring any one of the three would lead to much lower returns over time.

Market analysis is very important because it allows a trader to form a view of where the markets is headed medium to long term and if we should continue to participate. Please understand this is not market prediction as I don’t think anyone, myself included has that ability to get it right all the time. I am just forming a probabilistic viewpoint.

I am not sure what the exact statistics are but after investing and trading the markets for almost 20 years, I do believe that market drives about 75% of an individual stock’s move in the short term. Now you know why market analysis is important.

Most traders just focus on;

  • looking for a stock
  • then looking for technical entry signals
  • and trying to enter ‘perfectly’ forgetting that three quarters of that chosen stock’s move will be affected by the overall market direction.

On the other side of the spectrum, there are the value investors who do not care where the market is if they believe a stock is cheap enough to buy right away.

I do sometimes wonder why they would not just wait, if needed by maybe a few extra days and potentially have the opportunity to purchase at a much lower price because of the markets general affect on its price and hence be able to buy more when it does get cheaper?

History does not repeat itself exactly, but it sure does rhyme and ignoring history just because you are ingrained within one camp over the other means you may lose out on a few extra percentage point of compounded return over time.

In my own trading and managing funds on behalf of others, I am always studying the current environment to form my personal view of whether we are still in a bull, bear or sideways type market and hence this determines if and how I should participate in the current moment.

Studying history will help you avoid being caught up in another GFC style correction and most man-made market declines.

Another way I utilise market analysis is using my view of the market to determine my position sizes when an opportunity arises. For example, if I form the view which suggests that we are currently in a short-term high market risk, I will participate but reduce my investment or trading size to less than a fifth of what I normally put on.

In summary, market analysis allows the trader to form an opinion about the market and decide if it is currently safe to participate and if they do, at what size they should participate at. This helps immensely to reduce the overall portfolio risk you take everyday.

You are then able to ‘Be fearful when others are greedy and greedy when other’s are fearful’ and taking full advantage of human emotions.

I will end with saying;

“Know where the market is at and take advantage of this as it will set you apart from all other ‘average’ traders who trade stock in isolation to the overall market”.


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The Trader’s Mind: Getting Back to the Fundamentals of Trading
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Effective Trading Solutions Pty Ltd t/as is a Corporate Authorised Representative (CAR No. 1267698) and Terry Tran is an Authorised Representative (AR No. 1267697) of Australian Financial Advisory Group Pty Ltd (AFSL No. 475300).

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