Stock markets are not always rational. Despite warnings to the contrary, of bubbles or over-heated valuation, investors often pile into a sector when it is flying, ever hopeful that the bull run has much further to go.
A market is said to be bull market when it is rising. Those traders who say it will continue to rise are described as bulls. Those who believe the market will fall are called Bears and a falling market is a bear market.
In some instances, the bulls may be right. Charts and historic high points can be proved wrong as the market confounds traditional thinking. Take the gold price, back in 2009 City watchers were warning that the market was getting a little hot when the price broke through the $1,000 per ounce barrier and yet the metal continued to trade strongly before making all-time highs in 2011 of nearly $2,000 per ounce.
Undoubtedly there was a stampede into gold back in 2009 and those who timed their entry point well – possibly on the back of post-recession inflation and dollar weakness – will have seen good returns.
It’s a question of timing
Being bullish is all very well but if you went into gold at the tail end of summer 2011 you would have got little if any of the upside and felt the impact of a sharp correction in the Autumn when the price fell to $1,628 with further falls in subsequent years.
For most investors the onus is on identifying sentiment changes early which means entry and exit points are more focused and informed rather than knee-jerk reactions.
In strong trending markets, bull powers are normally positive and bear powers are negative. But when there’s a shift, that is bull powers turning negative and the bear powers turning positive, it signals a move to the downside in the markets.
The Bulls and Bears power indicator can point to emotional extremes of both bulls and bears. These extremes (either hugely positive or profoundly negative) are often short lived and unsustainable.
Basically, the EMA measures the market’s consensus on value and the High represents the maximum bullish power in the bar/candle. The height of the Bull Power histogram shows the spread between the high in price and the exponential moving average (EMA). The taller the histogram rises the greater the maximum bullish power. If the entire price bar falls below the EMA then the histogram will fall below zero.
The equation to establish bulls power is:
Bull Power = High − EMA (exponential moving average)
Where High is the highest (maximum) price in a certain period of time.
The Bulls Power displayed in a chart offers complete information about the buyers strength during the analyzed time period.
Understanding the transitory nature of extreme conditions, professional traders often fare better than armchair investors. When the market soars and the bulls are piling in, the pros short the market.
When market sentiment is in the doldrums and investors are running for cover, the pros will often seize what they see as a buying opportunity. This is often referred to as bottom feeding – purchasing stocks that have fallen victim to panic selling.
In an established bull market such bargains may be hard to find but good fund managers or individual investors will still find fair or under-valued stocks by looking at the fundamentals of a business. The fundamentals include improved cash-flow, strong order book, or maybe it is a turnaround story led by new management. They look for catalysts for change within the business that are likely, in time, to boost the share price.
The best investment strategies, whether in a bull or bear market, will look to factor in any data that could have an impact on trading bias. For instance, we mentioned earlier investors who traded gold on the back of a weakening dollar. Understanding direction within the currency markets is useful whether trading commodities, bonds or equities.
Rising currencies may help share prices in one country but send them down in another. Much depends on where companies in a country make their money – in their domestic market or abroad? For instance, large export companies can benefit from a weak domestic currency.
Meanwhile rising bond yields can often cause a nation's currency to appreciate. Markets are seldomly insulated from one another. In the same way as the Bull and Bear Power Indicator can provide useful insight, so too can the Currency Power Indicator.
The currency strength indicator calculates how strong each base currency is and assigns it a score from 0 -10 by comparing it against nine of its counter-currencies. A figure close to 10 indicates a strong base currency whose value is increasing. While a figure closer to 0 suggests a weak base currency, whose value is falling.
The investor gets a broad picture of how well each specific currency is performing against the wider market. For those specifically looking to trade FX, the Currency Power indicator helps identify currency pair combinations that are strong up or down trending.
There is no sure-fire way to exactly anticipate the start of a bull market or time to precision the best entry or exit point. But the more a decision is based on reliable indicators and less on herd mentality the better.