I once read about this economist from a long time back who said that one should invest one-third of his savings in real estate, another one-third of his savings in stocks and the last one-third of his savings in gold. I generally agree with him since this should be pretty robust in taking care of inflation, or any fluctuations from currency devaluation, and with some good timing of investment, this distribution of assets can yield very good returns with a very high Sharpe Ratio.
Total Saving = [1/3 * Stocks + 1/3 * Real estate + 1/3 * Gold]
However, now times have changed and there are many forces that are playing powerful roles in today's economy. Energy, Telecom, Internet, Software, etc. and influences of Globalization, are a few to mention. With increasing Globalization, political stability of the world is important and any small event in any part of the world can cascade to the rest of the world market. That is why timing the market is very hard these days.
I believe that the market movement is the net result of all forces that are acting on it. I have loosely used the word market in the above sentence, which can mean stock market, or bond market, or gold market, or oil market or commodity market or foreign exchange market or any market for that matter. The real challenge is in determining which forces are acting on the market and what the magnitude of each force is and hence what will be the net resultant direction of the market. To complicate the matter, many of these forces are short lived and may exert its force only for a small time and vanish later or may continue to exert. That’s why we have so many analysts go wrong in their expectations of market movement.
Yeah, that sounds similar to Newton's second law of motion. The acceleration is dependent upon the net force acting on the object and inversely proportional to the mass of the object. Similarly, markets need economic or political forces to drive them in either direction. And human desires, like greed and fear, provide the necessary momentum for the markets. The net resultant direction is the result of the dominant force on the market that day.
One of the forces that deserve special attention is the force from the mass psychology. Material reality might not have changed, but a change in trader's perception can result in unexpected movements. A good example is a typical statement from fed; though fed may not take any action from FOMC meeting, but their words can change people's perception and hence resulting in market movement.
I believe that net resultant of all of these forces should create a tug of war between supply and demand. And technical indicators are a good tool to use to determine the balance between supply and demand. Whether you want to buy when the supply is high or when the supply is low depends on you. I have been traditionally a Contrarian and hence I have chosen to get in when the supply is high; but going forward, I would like to explore, experiment being a momentum trader (also) and buy when the supply is low and sell when supply further lower.
-Nidhi
