Should you react to market moves or forecast them?
“What is the market going to do tomorrow?” is a very common question among market traders, in normal days and in current very unusual times. The answer you are going to hear from different traders is either “I don’t know” or a personal forecast up or down.
This is the difference between two types of traders : Some traders see the pattern in the market evolving and reacting to that price pattern, news or fundamental analysis info. This means they are waiting for the market to make a move, if that move is a recognized move, one that the market did in the past, the future move may be forecasted with high probability by anticipating the market to react as it did before. On the other hand, there are traders who disregard past moves and seek opportunities. By taking the bet before the market makes the move, they take a bigger risk because there are fewer facts to base their move on other than a hunch, which, for most successful traders pay off handsomely at the end in case they got it right. This is, of course, right along the time old lesson that risk is a part of the return. Low risk leads to low return and that high returns follow high risk. This does not mean that any of the traders type (reactors, forecasters) is reckless; risk should be managed in both approaches by following the open trade, making sure the loss is small in case the initial assumption was wrong and increasing the size of the open position in case the trade goes in your favor.
At AlphaOverBeta we react to the news, technical analysis or fundamental information. We run models that are based on loss management and risk mitigation to get the best return possible. Drawdown is just as important to us as returns. To make sure we don’t miss opportunities in the market, we use many sources of information to get all the high-quality data possible and mixing it into our prediction models to get the highest probability trades,.
Some sources we use:
- Macroeconomic data like interest rate, unemployment, GDP, etc to gauge the state of the economy at large to see if it can sustain market moves to the up or downside. This usually is our first step in our top-down approach. The economy is in fact moving slow but is a crucial infrastructure supporting the market. A sustainable move by the markets cannot be made without support from the economy. In the short term such divergence could happen, but in the long term the market goes where the economy points. Mind you, the market does not wait for the economy to point the way as markets are forward-looking. If traders conclude that in the next 3-6 months the economy will get better, they are increasing risk and vice versa.Under current conditions, perhaps its a bit early to discuss the recovery chain once this storm blows over. However, when judging from the 2008 meltdown (which was different in many aspects but its as close as we can get) we can observe that the market recovered much faster than the economy since markets are forward-looking and traders are always looking for opportunities. They lay at the bottom of the market nose-dive.
- Technical analysis is used as a guide in timing our entries and exits. We use many common TA indicators such as RSI, Stochastics, Bollinger plus proprietary indicators that have been developed over the years and are used to help us measure the trend, volatility, and potential of a specific trade.
As followers of the market, we don’t make full potential of every up or downturn since it has to occur first in order for our models to detect it and then react to it. Rather, we make trades based on recognized patterns that are in our playbook so we can invest our capital with high probability trades.
So for us the answer to the question “what is the market going to do next” is irrelevant. We don’t know, but what we do know is that once the market will make a move, it will be detected by our models, analyzed for probability and then managed accordingly. That includes these very confusing times when no one really knows where to next.