[caption id="attachment_26550" align="alignleft" width="108" caption="Chuck Root"][/caption]
What determines your success investing in the stock market? Like any business, you need a plan.
Did your results this year exceed your plan? As we begin a new year, it’s important to review our plan and adjust for our expectations of the new year. If you don't have an Investment Policy Statement, you have nothing to compare for 2010. Without a plan how do you know if you have done well? What was the risk in your portfolio? Looking at the monthly, quarterly or year-end results tells you nothing of the risk taken to get where you are.
Why a game plan? Have you recognized yet that you're playing in a very professional game? There are some very savvy investors in the world with the sole purpose of taking your money. A professional sports team would not go on the field without a game plan. Neither should you.
A game plan should include understanding what type of market we are currently in and when that market type changes. You need a game plan for all types of markets. There are volatile bear, volatile bull, neutral bear and neutral bull, to name a few. With a flexible game plan you can potentially make money in all types of markets. If your quasi game plan is to only be “long,” how do you know when to be out of the market or when to reduce risk? There are hundreds of factors in the market that can influence action and change when prices move in opposite directions.
Some advisers may tell you that the “pie chart” is the basis for investing and that you can diversify your portfolio to reduce risk. That by investing in “non-correlated” asset classes you can be relatively safe. In 2008, many asset classes and sectors showed a high degree of correlation when they all went down together. Look at a chart comparing all asset classes in 2008. By the way, even with the gains in 2009, some are still as much 25 percent down from 2008. We are in a structural bear market and have been since 2000, when the tech bubble burst. If you look at the S&P 500, you will find that you would have very little gain over the 1998-2008 time period, if you invested only in that index.
How then can you adjust to how the market works? There is a methodology that has been around since the early 1900s, that was conceived by independent thinkers who didn't follow the crowd. The methodology is technical analysis, which lets the market supply and demand influence when you should buy, sell or hold a security. There are several “flavors” of technical analysis, but the end goal is the same, know what the market is telling us. You can potentially make money even in bear markets with an effective strategy.
The operative word is strategy, since having a game plan is for each type of market, you will know when to be long, short or neutral (in cash). In bear markets there can be periods with significant gains, sometimes as long as a year or 18 months. Adjusting for market conditions can be a better strategy for capturing returns in such a market.