Thursday, October 13, 2011

Risk vs. Reward---When to be on the sidelines and when to back up the truck

As I write this the market is in rally mode for October and we are hearing the talking heads comment about how the crisis is over. What is an individual investor to do? Markets have trends and countertrends. Trends are the dominant move and countertrends are shorter term moves in the opposite direction. The market has been going up but the overall trend is still down so for now this is just a countertrend up move in a longer term down trend. Unless you are a speculator you should pretty much ignore countertrend moves and focus on the major trend. When the trend is down then the risk of being in the market outweighs the potential rewards and when the trend is up the returns outweigh the risks.

Right now we are still in a downtrend, so even though you may be able to make money chasing this market upwards the risk is extremely high. Investors are much better off being cautious until the trend changes. There will be periods like 1995-9, 2003, and 2009 where the market is in an uptrend and the potential for returns are much higher and the risk is much lower. In these periods it pays to take more risk.

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