Should You Avoid Stock Markets? is a post originally published on: Everything Finance - Everything Finance - Its all about Money!
In my experience as a financial analyst, one of the most popular questions I get asked is the following: Should I avoid stock markets? Fair question, I might add. The stock markets have a propensity to surprise us at the best of times. Stocks are characterized by cyclical movements and volatility, but avoidance is a foolhardy concept. If we extrapolate over time, it becomes clear that Wall Street bourses (NYSE, NASDAQ, Dow Jones, S&P 500, Russell 2000 etc.) have outperformed many other financial assets, and generated substantial returns for investors.
The Bull Market Continues in Earnest
Despite rather modest gains of late, Wall Street is still enjoying a bull run. Consider the current levels of the major indexes: the Dow Jones Industrial Average is currently trading at 21,235.67, the NASDAQ Composite Index is trading at 6,175.46, and the S&P 500 index is trading at 2,429.39. These numbers may look like nothing more than gobbledygook to the neophyte investor, but if we explore the performance of these indices for the year to date, everything comes into sharp focus. Consider that the S&P 500 index has generated returns of 8.51% for the year to date. That is a remarkable achievement, given that interest rates are currently in the region of 1.00% – 1.25%. If we extrapolate further, the Dow Jones Industrial Average is up 7.45% for the year to date, and the NASDAQ composite index is up 14.72%. The latter is particularly impressive, given that tech stocks suffered a major selloff in June.
Broad-Based Performance is Bullish
Given these figures, a trader would be hard-pressed to find better investments in the markets. True, the overall returns of these indices are impressive, but the performance of many stocks that comprise these indices may certainly fall shy of expectations. One of the questions that traders and investors need to answer before considering the stock market is the following: What is your risk preference? A Saxon Trade trading expert gave me sage investment advice recently when I asked him the same question. In his experience, traders tend to prosper when they select underlying financial assets that they understand. There are 4 broad categories of assets that traders can dabble in: stocks, commodities, indices, and currency pairs. Each of these is unique in the way it is traded in markets.
Forecasting with Technical and Fundamental Analysis
A series of interlinked and independent macroeconomic variables impacts the prices of these underlying assets. Sometimes the correlation between macroeconomic data such as gross domestic product, nonfarm payrolls, inflation, interest rates, US dollar index, business and consumer sentiment, Manufacturing PMI, services PMI etc. is sketchy. It may not always be clear how a rise in interest rates will affect the gold price, or the USD.
Generally, the theory is sound: rising interest rates lead to increased demand for the USD. This in turn causes an appreciation of the greenback, which negatively impacts dollar-denominated commodities like gold, copper, iron ore, silver and the like. The intricate nature of financial markets means that there is no crystal ball to ascertain the future price movements. We use technical and fundamental analysis to help us gauge the pulse of the market, in anticipation of forecasting future price movements.
As a novice trader, my advice is always to stick with what you know. If you understand the performance of the USD, the GBP or the JPY, stick with it. You may have a particular affinity to gold or silver, perhaps even the Dow Jones or the NASDAQ. Your knowledge of individual components of the financial markets serves as a gateway to a broader understanding of markets. Limit your individual trades to know more than 5% of your available capital – that way you are protected against volatility in markets. Demo trading is always advised, particularly if you have limited exposure to market dynamics and trading platforms.
