Maximizing Risk and Booking Bigger Profits Are Easy When You Follow Market Phases
Welcome! Whether you are new to trading or have years of trading experience, this e-book is for you because…
This ebook will enable you to identify the best time to enter a trade, and determine which trades have the least amount of risk with the greatest potential for gains.
Trade identification or knowing which instrument to trade can be daunting if you don’t have a simple way to know the true direction of the market.
Many investors are baffled by the media’s scaremongering. Often, confusion lies between the fundamentals of an asset and technical condition of its chart. Both types of analysis often come to totally different conclusions.
The “Gurus” are as varied in their analysis and opinions as there are instruments to look at.
Warren Buffett’s advice for the average person: Look at as many companies as possible and when you find the "bargains" you have to act. He says, "Start turning pages on 1000s of companies and turn the pages twice..."
He believes people should look for these companies themselves since, "The world is not going to tell you about great investments." Buffett believes, "the worst investment you can have is cash.”
Great advice, but very few can actually “turn the pages” once let alone twice and readily comprehend and then decide what to do with the information on those pages.
Does this describe your trading style?
If one or more of those statements describe how you feel about trading, you’re not alone. Trading is not easy, especially if you’ve not found a good source of trading education.
However, all of those frustrations listed above can be avoided when you understand how to read the Phases of the market.
Simply put, a “Phase” is the description of the direction and strength of the market’s trend. It is the “stage in the process” that most traders casually refer to as the market’s trend.
But you’re about to discover more than “trend”.
Your new ability to recognize Phases will enable you "see" the different stages of a trend clearly, and eliminate any mystery of the market’s next move.
There is something even more powerful than identifying a trend, and that is being able to perceive the beginnings and ends of a trend. To be able to do that is to be able to take full advantage of knowing when to be in and when to be out of the market.
Your new ability to recognize Phases will enable you "see" the different stages of a trend clearly, and eliminate any mystery of the market’s next move.
There are 6 market Phases. The above chart illustrates the flow of the 6 Phases in the market.
Most people are familiar with the terms “bullish” and “bearish”, but you can be more precise than that.
If you look at the chart like time on a clock, we begin with the Bullish Phase as High Noon. Moving clockwise from a Bullish Phase, the next phase is a Warning Phase.
Markets may move from a Bullish to Warning Phases as certain economic, geo-political, or even psychological factors spook the market and cause it to decline.
Knowing the Phase and what course of action to take in any given phase is like having your own GPS. This GPS works for the overall market, sectors of the economy, individual stocks, and almost any tradable instrument.
With a GPS, you never feel or get lost because you know your starting point and what direction you need to go next.
Successful technical analysts (chartists) will tell you that the chart precedes the news. Imagine, having the time to prepare for a downturn in advance rather than waiting for some “expert” to tell you that things are worsening.
In addition, picture having a jumpstart on investing or making good financial decisions way before the experts tell you to buy!
Even if you are not tuned in to the “news” or the reaction to the news 24/7, the Phase changes tell you so much; it is actually better than hearing the media or financial experts telling you what is happening. In other words, you will have all the information you need to make decisions, long before the “experts” advise you on the appropriate action to take.
Perhaps the most comforting feature of understanding phases, is that like everything in life, there are cycles. Eventually, everything moves through each cycle.
Often, as you will see later in this book, an instrument might move in between two cycles, going back and forth for a long time before finding momentum in one or the other. The comforting part is that even when everything looks disastrous, you know eventually, conditions and phases will improve.
In 2009, the Real Estate ETF bottomed. By the beginning of April 2009, the Phase changed from Bearish to a more positive Recovery Phase. This was a strong signal.
Perhaps some of you were following, but if you weren’t, that turned out to be the BOTTOM of the Real Estate meltdown and the bottom of the stock market for the next 6 years and counting!
Were the pundits telling you that? Was your Financial Planner helping you scope out cheap real estate deals? Were you prepared at all for perhaps the best opportunity in the real estate sector in this century?
Perhaps you saw this headline:
Industry | Wed Jun 24, 2009 2:02pm EDT
U.S. commercial property market thawing
(Reuters) - The gap between U.S. commercial property buyers and sellers is narrowing, indicating the shattered market is closer to beginning the painful path to recovery, the head of Prudential Real Estate Investors said on Wednesday.
Would you have believed this useful news story given that most Financial Planners and Money Market Managers were in the throes of Post-Traumatic Stress Disorder?
You might have if you looked at the Real Estate ETF chart and could independently recognized the Phase Change to Recovery - and a great one at that!
Forecasting direction naturally, is open to interpretation. Experienced investors who use technical analysis will use a variety of indicators besides moving averages.
For our purposes, I have found that keeping analysis simple is the easiest way to understand how predictions are made regardless of how much experience you have.
The constant blast of information available to anyone and everyone goes beyond overkill. Then add interpretations or “opinions” and it leaves you feeling numb, confused and alienated.
The moving average may be the most universal of all technical analysis indicators. For our purposes, we use the simple 50 and 200-day moving averages to determine any and all of the 6 Phases.
The 50-day moving average (“50 DMA”) is calculated by summing up the past 50 closing prices points and then dividing the result by 50, while the 200-day moving average is calculated by summing the past 200 daily closes and dividing the result by 200.
The 200-day moving average may be the granddaddy of moving averages. Simply put, a financial instrument that is trading above it is healthy; below it, anemic. The 200-day moving average measures the sentiment of the market on a longer term basis. This is where major players like pension plans and hedge funds need to look in order to move a large amount of stocks.
Imagine, just 2 simple daily moving averages can help you make the best trading decisions of your life, whether you are a day, swing or options trader!
The 50 DMA describes recent price trend; the 200 DMA describes longer term price trend. By examining current price in relation to these MAs, and the averages in relation to each other, we have an excellent toolkit for analyzing trends.
How Do You Identify a Bullish Phase?
In the above S&P 500 ETF or SPY chart, as 2013 began, all 3 criteria to confirm the Bullish Phase were in place. The 50 DMA was above the 200 DMA, the slope turned from neutral to positive, and the price was above both of the moving averages.
Literally, the first day of 2013, the price began sitting right on the 200 DMA and then proceeded to climb above it. On the second day of the year the price gapped higher, but it was still close enough to the 200 DMA that a Phase Change trade made sense.
If you had bought the S&P 500 or SPY anytime that first or second week of 2013, you still had time to use a decent risk to under the 200 DMA. You would have been buying around $145.00, risking around $5.00 to under $140.00. Even if you took the profit in June, once it broke the 50 DMA, you still made over $25.00 on that investment with just an initial risk of $5.00. That’s a profit that is 5 times the risk.
The chart below of the TLTs show that in late June of 2011, the Phase changed to bullish in the most powerful way.
Where I have highlighted, the 50 DMA crossed over the 200-day moving average in what is called a Golden Cross. When an instrument gets a Golden Cross, it indicates a bull market is on the horizon.
Looking at the 3 criteria for a Bull phase, the TLT chart certainly fits all 3 perfectly.
Interest Rates are easily followed by looking at the ETF TLT or The 20-Year Treasury Long Bonds.
Naturally, all phases fade in time, which is when we see the cycle go from bullish into warning, then distribution and eventually to bearish.
However, using the same 3 criteria for identifying a bullish phase:
You will always be one step ahead in planning your trading strategy.
Furthermore, after you determine the phase, you will be more informed than most traders and “experts.”
The S&P 500 (SPY) Bear Market of 2007-2009
Paul Tudor Jones, founder of Tudor Investment Corporation, a private asset management company and hedge fund and ranked as the 108th richest American and 345th richest in the world, was asked during an interview, “How do you determine the trend?”
He answered, “My metric for everything is I look at is the 200-day moving average of closing prices. I’ve seen too many things go to zero, stocks and commodities. The whole trick in investing is: “How do I keep from losing everything?” If you use the 200-day moving average rule, then you get out. You play defense, and you get out.”
The interviewer went on to ask, “You exited your long positions before the (1987 Crash)! Did your theory about the 200-day moving average alert you to that one?”
Paul Tudor Jones’ answer, “You got it. It had gone under the 200-day moving target. At the very top of the crash, I was flat.”
How Do You Identify a Bearish Phase?
During a Bearish Phase, heightened selling pressure ensues. Price closes below the 50 and 200 DMA and the 50 DMA turns down beneath the 200 DMA.
Without having to be one of the richest people in the world, you could have applied this same tactic at the end of 2007 and avoided the historic market decline in 2008
Paul Tudor Jones gave us the example of the 1987 crash and how he exited his long positions based on the move below the 200 DMA in the stock market.
Without having to be one of the richest people in the world, you could have applied this same tactic at the end of 2007 and avoided the historic market decline in 2008. As you can see in the chart above, the SPY fit all 3 criteria of a Bear Phase.
The best time to enter a trade with a low and reliable risk set up is when the price is sitting close to the moving averages as a Phase Change is about to occur.
Close to the end of 2007, just as the S&P 500 chart began entering the Bear Phase, the price was trading between $145.00 and $150.00. Investors had a chance to liquidate their long positions. You also had a choice to go “short” the SPY with a minimal risk as the price stayed close to the moving averages until later on in January 2008.
Had you gone short just under $145.00 as 2008 began, the risk was just over $150.00 or $5.00. Although by 2009, the price traded above and below the 50 DMA, it wasn’t until April 2009, the slope on the 50 DMA turned positive. At that point, the price was $77.00.
Knowing how to trend trade using Phases, could have yielded you a HUGE profit of about $70.00 with only a $5.00 initial risk. That’s a risk/reward of 15 to 1!
If the goal is to Minimize Risk and Book Bigger Profits Using the Phase changes, a short position back in 2008 generated the type of gains most wait a lifetime for and never achieve.
Trading Phases, you can score huge gains over and over again with easily defined, low risk trades!
Note that just as 2008 began, the 50 DMA crossed below the 200 DMA. This is the mirror image of a “Golden Cross” during the Bullish Phase. When the 50 DMA drops below the 200 DMA it is called a “Death Cross.”
With the slope of the 50 DMA very negative and the price below it and 200 DMAs, even the novice investor to clearly “see” that the market was in trouble.
Imagine, having the time to prepare for a downturn in advance rather than waiting for some “expert” to tell you that things are worsening.
Going back to the cycles of how Phases move, the Recovery Phase happens to be one of my favorites since it taps into perhaps the greatest attribute of us humans-hope!
After 2007-2008, during the intense Bear Phase, the switch into a Recovery Phase also tapped into exactly that - hope. Hope that the economy would improve, hope that the 2008 was truly, “the darkest period before the dawn.”
Looking at the SPY chart, by March 2009 the price crossed over the 50 DMA. By April the slope on the 50 DMA turned positive. Then in July 2009, the 200 DMA also became positively sloped.
Once all three criteria of the Bull Phase were in place the market’s trend was steadily up, and it was clear that the worst was over for the S&P 500. The Bullish Phase is one of the first trend conditions that active investors learn to trade because it is typically characterized by reasonable corrections and steady rallies, but the Recovery Phase is one of my favorites.
One of the most powerful times to buy an instrument is after it’s been in a long and powerful downtrend and begins to turn up, entering into a Recovery Phase. The change from a Bearish to Recovery Phase is a way to get into major trends early.
The change from a Bearish to Recovery Phase is a way to get into major trends early.
During a Recovery Phase, the 50 DMA is still below the 200 DMA. The price of the instrument crosses above the 50 DMA and the slope begins to neutralize. As the slope turns more positive, so does the strength of the Recovery Phase.
In the chart below you’ll see an example of a Recovery Phase Trade in the Russian ETF RSX. After a long decline RSX traded over the 50 DMA in February of 2015, and then its slope turned up in March which adds strength to a Recovery Phase trade.
The low risk trade opportunity occurred after RSX declined and closed under a positively sloped 50 DMA in March of 2015. When it quickly traded back over the 50 DMA, moving back into a Recovery Phase it became a good candidate for a trade.
On March 30th 2015, we entered long the Russia Country Fund ETF at $17.26. Our risk was minimal. We risked to $16.50 or 0.76%, which was just under the 50 DMA.
On April 16th, we took a profit target at $20.67, booking $3.41. Simply buying during a Recovery Phase when the price was close to the 50 DMA, kept our risk to a minimum and, gave us a risk to profit ratio of nearly five to one!
As of mid-May, we were still holding a partial position with a profitable trailing stop!
Using Market Phases to analyze the markets and identify trading opportunities is not hard. You can begin with the basics I’ve outlined here, and then quickly develop an expert’s insight into market direction with some practice.
If you’d like to learn more for your trading and earn more in your investing by using MarketGauge’s favorite strategies and tactics including Market Phases, please use the link provided below.
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Michele Schneider, Director of Trading Education and Research for MarketGauge.com, began trading on the floor of the NY Commodities Exchanges in 1980.
“Mish” worked for Conti-Commodities, a division of Continental Grain as an analyst and floor broker.
Soon thereafter, she became an independent floor trader. Known for her charting skills and technical analysis expertise, she has advised and continues to advise some of the top traders in the world.
In 2009, Mish created, “Mish’s Premium Service, a complete trading system for investors to f
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