Saturday, June 09, 2007

Correction, Recovery and Trend

On the following graph of the S&P 500 I've drawn lines indicating the three phases of each market cycle:Red lines mark corrections where the market has fallen 5% or more from a previous high. (Note that the current correction has only fallen 3% so far.) Green lines indicate fast rallies (recoveries) where the S&P erases its earlier losses and reaches new highs. Yellow lines are where the S&P 500 returns to its long term upward trend, making steady gains at a slower rate than a recovery.

In the last 5 cycles over the past 2+ years, every single correction (red) has completely erased the gains from the previous trend phase (yellow). In other words, buying at the bottom of each correction, selling when the market returns to the trend, and holding cash until the next correction, would have been better than buying and holding the S&P 500 throughout the entire period.

Of course it's difficult to sit on the sidelines during the the trend phase and watch the market going up further without participating in it. That's why I've spent so much effort looking for funds which can result in net gains during the trend+correction phases of each cycle.

In hindsight it would have made sense to buy an inverse S&P fund like SH at the beginning of each trend phase, since it ultimately would have resulted in a net gain at the bottom of the following correction. But watching an inverse fund shrink while the S&P goes up is even more difficult than being in cash, since there's no way of knowing when the next correction will occur, nor any guarantee that the next correction will fall far enough to make an inverse bet pay off.

1 comment:

Anonymous said...

wow... very nice work... good archives