5 Rules to Profit from a Bull and Bear Market Cycle
Thursday, April 3, 2008 | Jason JovineRating:
The big push this week is coming from the U.S. Treasury Secretary, Henry (“Hank”) Paulson. He is looking to streamline regulation in the financial markets, which is what typically happens after a bubble. Remember the 1990’s Internet boom? Any stock that had ".com" after its name went higher. Many of these companies had lousy earnings but, nevertheless, their IPO (Initial Public Offering) would skyrocket.
I made a BIG mistake personally by not buying EBAY (SYM: EBAY) when I had the opportunity to do so the day after it went public. I was so scared to lose money that I didn’t make money. The lesson that I learned back then was that scared money doesn’t make money.
It’s good to be cautious, but not too cautious. You have to be willing to assume some risk, as risk and reward go hand in hand. You will lose money if you just keep it in the bank. Inflation (especially nowadays) will kill that miniscule return that the bank gives you.
Way before the Internet bubble occurred, there was a bubble in the Netherlands in the 17th century known as “tulip mania.” In 1623, the average yearly income was 150 Dutch florins. By 1635, a sale of 40 tulip bulbs for 100,000 florins was recorded.
Tulips were thought of as a status symbol back then, so everyone had to have them. Naturally demand outstripped supply, and eventually there was a bust.
This, as well as other follies of human behavior, were discussed in Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay (1841). A quote from that book that stands out in my mind regarding the irrationality of crowds is: "Human beings are smart, but people are stupid."
Let's take a look at the stages of a bubble…
(Click to Enlarge Image)
We could argue about where we are on that graph, but I’m sure that we would all agree that we are no longer at the Euphoria stage.
Ideally, we want to buy stocks at the Point of Maximum Financial Opportunity on the graph. We are certainly not there yet. Yesterday, Fed chief Ben Bernanke warned of a possible recession. More specifically he said:
"It now appears likely that gross domestic product (GDP) will not grow much, if at all, over the first half of 2008, and could even contract slightly."
He then went on to say that he expects the interest rate cuts, as well as the tax rebate checks being sent out, to start having a positive effect on the economy late this year and into 2009.
When will we see the Point of Maximum Financial Opportunity?
The short answers is: you want to buy when everyone and their mother are selling, and you want to sell when everyone and their mother are buying.
Do not try and time this Point of Maximum Financial Opportunity!
You will NEVER buy at the absolute bottom, and you will NEVER sell at the absolute top. DON’T KID YOURSELF!
It is a home run if you buy within 20-30% of the bottom or sell within 20-30% of the top. Don’t be too greedy, and don’t be too fearful (remember my eBAY lesson).
I am referring to individual stocks as well as the market as a whole…
Look at Citigroup (SYM: C):
Citigroup was at about $18 on 3/17/08, and, as I write this, it is at about $25. This is almost 40% higher. Everyone was scared about financial stocks because of their write downs, etc. Now, I see articles weeks later taking about how great they are.
In closing, folks:
1. People (as reflected by the stock market) are irrational.
2. Don’t try to call bottoms and tops perfectly on stocks or the market, because you won’t.
3. You can take more risk in a bull market, but don’t go overboard.
4. In a bear or a sideways market, buy the names on the dips.
5. Use commodities, bonds, and currencies to diversify your portfolio. Don’t just be a “stock” person.
Until the next time folks...
P.S. Where do YOU think we are on the graph right now?
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Jason Jovine
Contributing Editor
The Tycoon Report
