Gabe Varga, CMT

Gabe Varga, CMT
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The Fidelity Trends blog is a market commentary for Fidelity mutual fund investors. Our goal is to highlight key changes in market conditions using technical analysis tools.

A unique feature of our blog is that we rely on technical screens and model portfolios that are provided by our sister sites, Fidelity Sector Report and Fidelity Signal (see more on our home page at axiomix.com). Once we identify opportunities and risks using the quantitative tools, we provide additional analysis on this blog site.

The technical screens and the charts are unbiased, but our interpretation is not. Please feel free to comment if you have additional thoughts on a given subject.

We hope that our market insights can help you to make more informed investment decisions when managing your 401(k) retirement account, saving for a nest egg, investing for college education, or developing retirement income strategies.

The sections below provide more explanation on our philosophy, approach, and methods for analyzing investments.

Misbehavior of Mr. Market

We are inspired by “The Black Swan: The Impact of the Highly Improbable“, a bestseller book by Nassim Taleb. However, the recognition of the often unpredictable nature of the stock market and the devastation caused by unlikely events described by Taleb is not new.

Benjamin Graham, author of the famous book “The Intelligent Investor“, referred to “Mr. Market” as a schizophrenic. In addition, Benoit Mandelbrot‘s “The (Mis)behavior of Markets” book provides insight into erratic market action using the chaos theory.

Alchemy of Financial Bubbles

George Soros, the famous hedge fund manager, and philanthropist, describes the intriguing concept of reflexivity in his bestseller book “The Alchemy of Finance: Reading the Mind of the Market“. Reflexivity describes how the biases of investors and traders change the perception of the fundamentals of the economy; essentially creating a feedback loop that can reinforce financial booms and busts.

Soros argues that the markets are more often in a state of disequilibrium rather than in equilibrium.  In that light, it is not surprising to see that the history of the financial markets is full of bubbles, manias and crashes (see the investment classic book “Manias, Panics, and Crashes: A History of Financial Crises“). How is it then possible for individual investors to make money?

Avoid the Random Noise

It is possible, but not easy to consistently make money by trading the financial markets. First, investors have to better understand the underlying forces of market behavior, and secondly, choose the right analysis tools to aid decision-making.

Our philosophy is that the market alternates between periods when random noise dominates and periods when a trend is in place. It is in the trending periods, whether bullish or bearish, when momentum investors have the best chance to generate investment gains. Conversely, in random markets, it is difficult to make money and the best strategy is to preserve capital by building cash reserves.

In our analysis, we turn to the tools of Behavioral Finance (see Prospect Theory below) to help us understand and interpret current market conditions. Moreover, the tools of Technical Analysis help us further diagnose market conditions, identify investment areas and sectors where a trend is in place, and to find entry and exit points.

Greed, Fear, and Hope

Nobel Prize winner Daniel Kahneman along with Amos Twersky developed the Prospect Theory (see Nobelprize.org or wikipedia.com) to show how people make financial decisions under uncertain conditions. Their findings have roots in the works of Daniel Bernoulli, the famous mathematician of the 18th century, who first formalized theories around the “utility of money”. Bernoulli defined concepts such as risk aversion and the value of financial gains versus the risk it takes to obtain them (see wikipedia.com).

The influence of fear, greed, and hope on human decision-making, as described by the scholars, stays unchanged today and continues to drive investors’ response to risks and opportunities. Indeed, these overriding emotions are hard-wired in our “reptilian” brain stem and are difficult to override. As a result, our financial decisions are often clouded by emotions evoking the fight or flight response.

The fight or flight response is not the only emotional reflex investors have to be aware of. Another common human behavior involves ignoring reality for years and then throwing in the towel exactly at the wrong time while making losses permanent and leaving little hope to recover. Furthermore, many investors find themselves sitting on the sidelines, not daring to jump in when markets take off.

Learn from the Past

Luckily, there is a better way to make financial decisions than relying on impulse. Just like running a business, investing money requires attention to performance, the ability to act under uncertain circumstances, and the skills to make trade-offs between risk and reward.

We created the FidelityTrends blog for investors looking for an alternative to the buy-and-hold strategy. This strategy clearly did not work very well in recent volatile markets.  Remember the Internet bubble bursting in 2001, the housing bubble and the near collapse of the banks in 2008, which was followed by European financial crisis in 2010?

Luckily, the financial system recovered from the Great Recession of 2008, however, the Dow Jones Industrial average had a negative return in the first decade of the new millennium. Will financial history repeat itself, perhaps in a slightly different form? We think that it is very likely.

How can Technical Analysis Help?

Using Technical Indicators to stay on the right side of the trends can be extremely helpful in taming the bubbles and avoiding the market crashes.

Is it unusual for the financial markets to have a prolonged losing streak? It turns out that challenging investment periods happened repeatedly in the past. For example, it took the Dow Jones Industrial average 25 years to recover after the 1929 crash. Also, the Dow index had a negative return for the sixteen-year period starting in 1966.

During these prolonged periods of market weakness, buy-and-hold investors were faced with holding declining assets for 10 or more years. However, in spite of all the risks, investing in stocks and bonds using smart strategies has proven to be one of the best ways to build wealth.

The new millennium brought changes to our lives and to our investments. For one, electronic trading became dominant and financial markets seem to be more volatile now. In addition, the buy-and-hold strategy that worked so well in the 1980s and 1990s has resulted in extremely high risk and very little real return for investors between 2000 and 2010. That is why we believe that the years ahead will require more flexible approaches than the buy-and-hold strategy. In our view, technical analysis is one of the best approaches available for supporting investment decisions, because it can provide an unbiased view of the market.

The Trend is Your Friend

We must learn from the past and find new ways to gain an edge in order to avoid sub-par investment returns. Technical Analysis, the study of price trends, volume patterns and inter-market money flow, provides us with excellent tools to interpret the market action.  Imagine being in a safe cash-equivalent investment (e.g. a money market fund) during a prolonged bear market, but participating in strong bull market periods. Trend analysis can help investors achieve these goals.

To identify bullish uptrending markets around the world, we apply a simple and time-tested trend analysis approach, the 100-day moving average. First, we adjust the historic prices for dividends and capital gains distributions to avoid the distortion of the price patterns. Next, the moving average is constructed by averaging the closing prices of a given mutual fund over a 100-day period, including the days when the market is open.

By our definition, a mutual fund investment is in a bullish uptrend when its price (a.k.a. Net Asset Value) is above the average of its recent prices represented by the 100-day moving average. Consequently, we can use the 100-day moving average as a trendline for identifying intermediate-term trends. Since both human behavior and business cycles tend to exhibit seasonal trends, the 100-day moving average becomes the perfect tool for capturing bull and bear market moves lasting three to twelve months.

The result of using the 100-day moving average is an unbiased and quantitative view of the performance of the mutual funds we track. Our market commentary is based on this simple, but highly effective approach and aims to highlight the prevailing trends in domestic and international markets. Using Technical Analysis enables us to screen mutual fund investments for profitable trends, to avoid market noise, and to see where market leadership is emerging. Furthermore, we are always excited to uncover new investment opportunities.

Why Mutual Funds?

There are many ways to participate in the financial markets, but our main focus is on mutual funds, simply because tens-of-millions of Americans own them in their retirement or taxable accounts.

We especially like mutual funds by Fidelity Investments, because of the breath of no-load investment choices they offer from sector funds to investments in international regions, as well as the long-term track record and the high quality of the fund management they provide.


Disclosures: The FidelityTrends blog site is independent of, and not affiliated with Fidelity Investments.

Disclaimer:  The FidelityTrends blog site does not offer personalized advice and is not an investment adviser. The views expressed on the blog site are for informational purposes only.

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