Pretend, for a moment, that you have a gut feeling the market will be falling. You think that oil, the hurricane, the economy, whatever, is going to ultimately bring down the market.
Should you get out of the market entirely?
Making a decision to “get out of the market” and sell all your stocks is an incredibly risky wager! You are essentially drawing a line in the sand and deciding the market will never again go higher. I say this is a risky bet because, historically, the market goes up two thirds of the time and down one third of the time.
Which would be the better direction to go?
Well, Step One would be to determine if we are currently on “offense” or “defense” in the market. Markets go up and down whether or not there is an oil crisis, a war, or economic hard times.
Knowing who has control of the football allows you to run the proper plays in your portfolio. You wouldn’t punt and give the ball away on first down in football; likewise you would not want to sell everything while on offense in the market either. When we are on offense, we want to run plays (use strategies) that will help build the value of our accounts.
Now, when the market is on defense, the play-calling changes. On defense, we’ll use strategies that will help us protect our investment. We do this so we can be ready to play when we regain control of the football.
Step Two would be to examine which sectors are currently in favor and where our investments stand in relation to this analysis.
These two steps are crucial to determining whether the odds (the risk) are with you or against you. They must not be skipped!
Let’s say the market is moving from offense to defense. What would be the next step? Sell everything? As we said earlier, we know the market goes up two thirds of the time and down one third of the time. Selling everything implies a doomsday scenario and is usually a bad idea.
If you’ve completed the first two steps, go to step three.
Step Three, sell any stocks (or mutual funds) that have poor relative strength. What is relative strength? How a stock (or fund) performs compared to the overall market.
Stocks are either on a relative strength BUY signal or a relative strength SELL signal. Did you know that relative strength signals (buy and sell) last, on average, for TWO YEARS? Meaning a stock that gives a relative strength buy signal today will usually outperform the overall market for (on average) two years. That’s a long time!
Next, Step Four. Examine the stocks or funds that have good relative strength. Stocks (and mutual funds) with good relative strength tend to snap back quickly when the market rebounds.
On the flipside, stocks with poor relative strength tend to fall with the market (and many times will fall further than the overall market).
Relative strength is a very important part of the decision process we use at Mullooly Asset Management. Knowing the relative strength of a stock or a fund will clue you in on its potential performance during rough times.
Let’s take relative strength two steps farther. We now know we can measure relative strength for an individual stock (or mutual fund) versus the market. But did you also know that we can measure a stock (or mutual fund’s) relative strength against its peer group too? That would help us decide if we should jump over to another horse in the race.
Perhaps you have money in a stock that is in a favored sector; but the stock you own has poor relative strength. You want to stay in the sector. Moving within the sector to another stock in the group with better relative strength is a smart way to go.
We can also plot the relative strength of a sector compared to the market as well. Knowing a sector’s relative strength versus the market is VERY important! Oftentimes, when a sector turns up, it can be like watching a school of fish move...they all move at once. And today, you can instantly have money in that sector through buying an exchange traded fund (ETF).
Likewise, when a sector gives a relative strength sell signal versus the market overall, the whole group usually moves again. You’d want to reduce the amount of money in that sector as soon as possible, and perhaps get out of the group entirely.
Thomas P. Mullooly, President of Mullooly Asset Management, LLC ( http://www.mullooly.net/ ) has spent over twenty years in the investment industry, as a broker and as an investment advisor. Mullooly Asset Management is a fee-only registered investment advisory firm based in New Jersey, specializing in retirement plan accounts, particularly managing 401k, 403b, and deferred compensation accounts for individuals. Feel free to contact us to check out the relative strength of your portfolio by sending an email to tom@mullooly.net or visiting http://www.mullooly.net/403b-plan.html or sign up to receive the market report and tips on how you can soundly invest your money at http://www.mullooly.net
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