Six Common Trading Myths

Mar 31, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on Six Common Trading Myths

Ryan Detrick is a Senior Technical Strategist at Schaeffers Investment Research. And although I caution against trusting everyone on financial television, this guy is great. He is a frequent guest on CNBC, Fox Business, and Bloomberg Television. Be sure to follow him on Twitter or StockTwits @RyanDetrick or read his market thoughts at www.schaefferstradingfloor.com.

Ryan recently wrote a guest post for seeitmarket.com (http://www.seeitmarket.com/market-masters-trading-myths-revealed-13562/) about six of the most common trading myths. Not only did he describe the myths, he went on to give hard examples of why they are just that, myths.

For example, have you heard of the saying, “Sell in May?” That has been a popular saying for years, but now May is actually up on average since 1980. Ryan points out that times change and traders must adapt if they want to remain successful. That is why Tim buys and sells stocks, rather than just shorting like he did to make his first million. Being able to adapt to different trading environments will both keep you successful and give you more opportunities. Adapting will help you stay ahead of the game.  Ryan says that “Adapt or die” is one of his favorite trading rules.

Here are the six myths that Ryan debunks.

#1 Light volume is bearish

This is one that has been around for a while and became even more prevalent since the financial crisis. Since at least September 2009 the bears have been saying volume is light, and this is a warning. But here are the facts.  Overall, NYSE volume is indeed lower than historical standards:

NYSE-volume-chart

However, there’s a catch. This volume didn’t just disappear, people adapted to the types of securities available. Have you heard of options and futures?  Traders have moved to those securities as well. Take a look at equity option volume and you’ll see quite the different picture.

equity-option-volume-since-2000

Now what about the fact that stocks are more expensive than five years ago?  Of course volume is lighter now when Apple is $500 versus when Bank of America was around a buck.  You can’t buy 500 shares of Apple the same way people used to buy 500 shares of Bank of America (that’s $250,000 vs. $500)! To gauge this, Ryan looks at all stocks in the S&P 500 Index (SPX) and finds their daily average dollar volume (this is the stock price multiplied by the stock volume). Then, to smooth things out, he takes a 21-day moving average of the results. Below is a chart of what he found.

spx-average-volume-chart

Total-dollar volume is certainly less than during the peak of the financial crisis. But it’s also well above the bull market from 2003 to early 2007. You must ask the question: If total-dollar volume is higher now than the last bull market, how in the world can bears say lower volume is bearish?  Not to mention spikes in volume tend to occur during pullbacks, like when Tim shorts a pump and dump or a company comes out with poor earnings results.

#2 Copper is crashing, which suggests a slowing global economy and a warning for stocks

Many people look to “Dr. Copper” for predictions in major trends in the global economy. So now that copper is breaking down to multi-year lows, Ryan checked to see just how accurate this Doctor is. As it turns out, when copper makes a new 2-year low, the S&P 500 doesn’t tend to do too bad.  Three months later it is about flat, but a year out it jumps 17%. Check out this table:

equities-performance-after-copper-price-low

Here’s a chart as well, and it sure makes it hard to say this is bearish for the S&P 500.

copper-2-year-price-low_equities-chart

#3 Big up days are always bullish

I didn’t even know this one, but there is quite the funny statistic about huge up days (or a rise in prices) in the market….they usually happen in bear markets! Last year, when the S&P 500 had a great year returning roughly 30%, it saw just three days gain more than 1.5%. Compare this with 2008 when the index dropped 38%, and the market saw 43 days gain more than 1.5%.  Slow and steady usually wins the investing race.

historical-stock-market-up-days-above-1.5-percent

#4 The Dow is up five years in a row, and this has to be bearish as we’ve gone ‘too far, too fast’

The 10-year annualized return on the Dow is about 5%. In fact, bull markets don’t end until closer to 15 to 20 year runs and an annualized return of closer to 15%. That would mean we are only about half way through the bull market run!

dow-jones-10-year-return-annualized

Everything isn’t perfect though (as it rarely is), and the 5-year annualized return is getting up near previous peaks. In fact, we are now above the peak in 2007, but well below some other peaks. This can be classified as a potential near-term warning, but not a signal this bull market is dead either.

dow-jones-5-year-historical-return-annualized

#5 This year looks a lot like 1929, so we’re going to crash

You’ve probably heard a lot about this one.  Turns out the chart today looks just like the chart in 1929 before the crash (we wrote about this here: http://blog.profit.ly/2014/02/20/the-scary-chart-being-shown-around-the-internet/). Well, like we said in our blog post, Ryan reiterates that it isn’t quite that simple. Yes, on a daily chart, things look a lot alike, but when you look at the percentage returns, there is a different picture.

dow-jones-current-vs-1929-crash-chart

dow-jones-percent-return-current-vs-1929-period-chart

That same chart that is causing so much fear doesn’t look so similar now, does it?  The rally into the ‘29 peak was a historic blow-off top.  I’m not saying this current one isn’t getting ahead of itself, but the second picture is a more ‘apples to apples’ comparison according to Ryan, and we’d have to agree.

#6 Earnings predict the stock market

This trading myth was picked up by thereformedbroker.com as well. Last year the S&P 500 gained nearly 30% while earnings jumped less than 6%. Earnings gained 6% in 2002 and the index lost 23%.  There was a huge 37% jump in earnings in 2010 while the S&P 500 gained just 12%.  Then there was flat earnings growth in 2009 and a nice jump of 23% on the S&P 500.  I can’t figure out a pattern there, can you?

historical-sp-500-earnings-growth-and-returns

spx-vs-corporate-earnings-historical-performance-chart`

There are many more myths out there, but these are six of the biggest ones, and Ryan does a great job of illustrating why they are myths rather than actually trading tools.