When we invest in the stock market, for most of us, we have our life’s savings at stake. We like to make money and preserve our savings. We like to foresee what is coming so we can achieve our goals without losing money. However, nobody can predict exactly where the market will be. We can only guess at its future. There are guesses and there are guesses; some are better than others. Here is an attempt of mine to see where it is going and, based on which, I try my best to steer my investment course.
The following chart is a favorite of mine and it is also the starting point of my look at the market. You can get this chart from Yahoo. This chart covers all the DJIA price data Yahoo has up to October 12, 2011.
It tells us the DJIA has been moving up steadily. It also tells us the DJIA has been gyrating wildly recently, and has not been moving up. You can see this very clearly when you limit the chart to the last 17 years as shown below.
Since 1999, for about 12 years, the DJIA has been stuck at around 10,000, going as high as about 14,000 and as low as about 7,000. I am using round numbers in this discussion to illustrate the points I am making.
Now, if you look even closer, the DJIA had gone as high as 12,800 during QE2, but for the last two months it has been meandering between 10,600 and 11,600.
What do this tell us?
- Eventually the DJIA will break out from the current trading range of 10,600 – 11,600. It is only a matter of how long it will stay within this trading range.
- Will the DJIA break out from the 12 years of circling around 10,000? What would make it to go above the historic high of 14,000? What would make it revisit the 7,000 low?
You can never predict when the market is going, but you can plan for what you are going to do when the market does a certain thing. Sometimes, the market moves so swiftly that you don’t have time to react. Therefore, planning is everything. It is never too late to plan.
Planning is never easy, but you must think hard now and come up with plans actions for the following situations:
- In the short term, what would you do if the DJIA moves above 11,600 or below 10,600?
- In the medium term, what would you do if the DJIA moves above 14,000 or down toward 7,000?
- In the long term, what would you do if the DJIA resumes the long term trend upward or if it fails to do so?
You may not be able to come up with what to do in all of these situations; however, having some plans is better than having none.
Here is a suggestion. You may divide your investment in five parts for the five possibilities:
- Part 1: For when DJIA goes over 14,000
- Part 2: For when DJIA is between 11,600 and 14,000
- Part 3: For when DJIA is between 10,600 and 11,600
- Part 4: For when DJIA is between 7,000 and 10,600
- Part 5: For when DJIA is below 7,000
You may divide your investment in five equal parts. Or, you may have a 1-2-3-2-1 distribution for the five parts. If you are an optimist, you may put heavier weights on the top two parts. And, if you are a pessimist, you may put heavier weights on the bottom two parts. Adjust the distribution to fit your personal view of the market.
I am a DIA investor. So let me address these five parts in terms of DIA.
- Part 1: I would use this part and accumulate DIA, either now or at lower prices, to sell when DJIA goes over 14,000. I do not have to invest only in DIA. I may invest in energy, financial, technology, or other ETFs. This is for the long-term and I wouldn’t invest in a single company. I may switch it around as the market moves on. This must be a very solid investment. I would probably not invest in commodities or their ETFs because, in the long run, they may rise only as much as the inflation does. I am looking for something that would do better than inflation.
- Part 2: I would use this part and accumulate DIA, also either now or at lower prices, for sell and trade when DJIA is between 11,600 and 14,000. This part of investment may become all cash when DJIA reaches 14,000. One of the hardest investment decisions to be made is when the market is near its all time high. We tend not to cash out only to see our paper gain disappear.
- Part 3: Right now, DJIA is between 10,600 and 11,600. I would take this part and trade it like I have described elsewhere (Poor Man's Program Trading After Two Months). Again, when DJIA reaches 11,600, this part of investment may become all cash.
- Part 4: I would accumulate more DIA when DJIA drops from 10,600 to 7,000. I would spread this part of investment evenly over this range. When the market recovers from this range, I may cash out near the top of the range.
- Part 5: In the unfortunate event that DJIA does drop below 7,000, most people would have left the market long before it gets there. However, if I still have confidence in the economy of the U. S. then, I would buy some more DIA as the market descends. (Because of this possibility, you never put all your money in one basket – the stock market.) When the market recovers from a dark hole like this, I would be so happy that I would cash out this part of investment as soon as it gets out of this range.
This is just one illustration of how we may roll with the punches as the market makes its moves.
Disclosure: I am long DIA.