Stock Market Update: What a 9.5% Rally Means Next
So there is some evidence for an optimistic near term, however, it is important to be aware that the numbers above are just averages. The range of 50 day price moves following the largest up moves was:
- Maximum +62.6% (10 June 1932)
- Minimum -33.8% (10 October 1929)
So if you could play the game an infinite number of times you would certainly go long and expect to win over time, but we don’t get to play this game very often, and there is still a decent probability of a -20% move down from here.
I really like doing this sort of investigation because it shows what could happen (not what will happen). Understanding the range of outcomes is useful because it can help us do some mental scenario analysis on our portfolio.
Ask myself questions like:
- What would happen to my portfolio if the market fell 20% over the next 50 days?
- What would happen to my portfolio if the market rallied 62% over the next 50 days?
- Does my mix of systems and capital allocation protect me sufficiently from such a massive range of possible outcomes?
- Am I mentally prepared for anything that could happen?
- Would I have confidence in my systems to keep me safe (and profit) in the full range of possible outcomes
Mental scenario analysis is one of the best ways to improve as a trader because it prepares you for what could happen, so that if it does you can act rationally. It also gives you extreme scenarios which you can use to pressure test your important things like:
- Capital allocation
- Position sizing
- Long/short exposure
- Trend following / mean reversion balance.
This builds your confidence that you will be ok no matter what happens.
Looking at the daily chart of the indices below is really quite interesting. The US markets had a huge bounce on Wednesday but are still well down from their peak and below the 200 EMA. This is useful to remember as despite what the scatter chart above shows, long term holds do perform much worse when the index is below the long term moving average, and volatility on average is much higher.
Remember ever trade I make is 100% systematic, so I am not making any discretionary decisions here, but if I was, I would be waiting to see if the market managed to sustain a rally and rise above the 200 EMA before I got excited about a new up trend.
