Should I Buy or Should I Sell Now?

Whenever we see dramatic moves in the market, reporters and analysts become very emotional. After the market has made significant gains over a three-day period, the major news channels bring out the cheerleaders to pump up their audience and sing the praises of a bull market. We are provided every reason for the market’s rise, and even more for its continued upward surge. After a fall over the same period, we are subjected to every Chicken Little who is willing to stand in front of a camera, shouting, “The market is falling, the market is falling”. These purveyors of doom and gloom have just as many reasons for the continued drop. As most of us with any experience in the markets can attest, rarely are these extremists right, but why is this true?

This is true because the market already has this information. Good news, accounting for a market’s rise, has already been factored in. Bad news, and the potential for more bad news, has also been factored in. This is how the markets work. This has been true since the beginning of organized markets and remains true today. Advances in information technology only enforce this basic truth. Hindsight is 20/20, and any analyst, reporter, or market researcher commenting on the past, or even the rumored future, will also be behind what is already priced into the market.

One example of this is the historical data relating to the S&P 500 Index. Since 1989, anytime the index has dropped three straight days, it has rebounded over the next five. Not only did it rebound, it went up nearly four times its average weekly gain. On the upside, after three full days of gains, the index has followed that with a net gain of nearly zero over the next five trading days. We can find this same price behavior by looking at the NASDAQ 100 Index as well. What does that mean for traders? Don’t chase the market. Look to buy after the market has dropped, not after it has risen.