Profits In The Stock Market With Charts BEST

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Profits in the Stock Market With Charts

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Image Description: The graph shows the fed funds rate and the S&P 500. History is mixed on whether a Fed pause can be enough to end bear markets. But similarities of the current bear with the one from the 1970s suggest that equities might not require aggressive rate cuts to bottom.

When stocks plunge a natural impulse can be to hit the sell button, but the firm found the market's best days often follow the biggest drops, so panic selling can significantly lower returns for longer-term investors by causing them to miss the best days.

"Whereas valuations explain very little of returns over the next one to two years, they have explained 60-90% of subsequent returns over a 10-year time horizon," the firm noted. "We have yet to find any factor with such strong predictive power for the market over the short term."

At the beginning of best-selling book How to Make Money in Stocks, IBD Founder and Chairman William J. O'Neil shows 100 charts of the top-performing stocks over the last 100+ years. Whether it was General Motors in 1915, Coca-Cola in 1934 or Priceline.com in 2006, they all built the same types of patterns.

For best results, buy as close to the ideal buy point as possible. If you're not able to watch the market during the day, you can set conditional orders ahead of time. Those trades get automatically triggered if the stock hits your target purchase price. Ask your brokerage service how to set those up.

• Once a stock climbs more than 5% above the ideal buy point, it's considered extended or beyond the proper buying range. Stocks often pull back a bit after a breakout. So if you buy extended, there's a higher chance you'll get shaken out of the stock because it triggers the 7%-8% sell rule.Volume on day of breakout: At least 40%-50% above averageOn the day a stock breaks past its ideal buy point, volume should be at least 40%-50% higher than normal for that stock. That shows strong institutional buying. On many breakouts, you'll see volume spike 100%, 200% or more above average. Light or below-average volume could mean the price move is just a head fake, and the stock is not quite ready for a big run.

Learn to recognize different chart patterns with IBD home study programs.

So in most cases (see the 8-week hold-rule exception), you're better off locking in your gains to avoid watching your profits disappear as the stock corrects. And you can potentially compound those gains by shifting that money into other stocks that are just starting a price run.

P/E ratios are a cornerstone of fundamental stock valuation analysis, and are most commonly looked at for individual firms. The P/E ratio is (as the name suggests), a ratio of a stock price divided by the firm's yearly earnings per share. The implied logic here is that a mature firm returns all profits to shareholders via dividends. The P/E then becomes a measure of how many years it will take the investor to earn back their principal from the initial investment. For example, if you buy 1 share of ACME Co for $100, and ACME consistently makes profits of $10 per-share, per-year, then it follows that it would take the investor 10 years to earn back their original $100 investment.

P/E is calculated using the last reported actual earnings of the company. Let's look at another example - one where we expect future earnings to grow. Imagine TechCo was founded 5 years ago, and their earnings per year (per share) have been $0, $1, $1.50, $2, and $5. Let's also assume that TechCo's current share price is $100, just like ACME in the prior example. Because the most recent earnings-per-share for TechCo is $5, that means TechCo's P/E ratio is $100/$5 = 20. The message here is that, at current earnings, investors in TechCo will theoretically get their money back after 20 years. This is twice as high as ACME -- but why? If it takes twice as long for TechCo to make profits as it does for ACME, why is their stock valued at the same price? The answer is obviously the growth rate of TechCo's profits. TechCo is a new company, and has been growing profits very quickly over the last 5 years, and so investors expect that trend to continue. This is why high growth companies tend to have very high P/Es - the market has very high expectations for their future results (relative to current results).

The same analysis can be done to the entire stock market. By adding up the price of every share in the S&P500, and comparing that to the sum of all earnings-per-share generated by those companies, you can easily calculate the P/E ratio of the US stock market.

The chart above shows the standard calculation of the S&P500 PE ratio since 1950. Since this is a measurement of current price divided by most recent earnings, the calculation is subject to high volatility caused by peaks and troughs in the business cycle. For example, in mid-2008 at the nadir of the financial crisis S&P500 earnings across the board fell about 90% in about one year. Despite stock prices also going down significantly, this caused the market P/E at the time to spike over 120.

The primary case against using historic PE as a valuation metric is the idea that PE ratios ought to be getting more expensive over time. Here is one cogent example of this argument. Changing market structures (e.g, heavier weight on growth tech stocks) can reasonably drive increased average CAPE ratios over time, as could a multitude of other exogenous factors (e.g, interest rates).

There is no arguing that the CAPE ratio has risen over time, and particularly since 2000 when tech/growth stocks have becoming increasingly dominant in the S&P500. We agree that it doesn't make sense to compare today's market to the 1800's, and so this criticism is primarily why we do not use data prior to 1950 in this model.

This lack of correlation has a simple explanation. The Chinese stock market has been historically dominated by largely unprofitable state-owned enterprises (SOEs) and has not reflected the otherwise highly dynamic economy.

But China is hardly an outlier. Elroy Dimson, Jay R. Ritter, and other researchers have demonstrated that the relationship between economic growth and stock returns was weak, if not negative, almost everywhere. They studied developed and emerging markets across the entire 20th century and provide evidence that is difficult to refute.

To explore the relationship between US stock market returns and earnings growth, we first calculated the five-year rolling returns of both time series using data from Robert J. Shiller at Yale University going back more than a century. From 1904 to 2020, earnings growth and stock returns moved in tandem over certain time periods, however, there were decades when they completely diverged, as highlighted by a low correlation of 0.2.

The perspective does not change if we switch the rolling return calculation window to one or 10 years, or if we use real rather than nominal stock market prices and earnings. The correlation between US stock market returns and earnings growth was essentially zero over the last century.

But knowing the earnings growth rate in advance would not have helped these superinvestors time the stock market. Returns were only negative in the worst decile of forward earnings growth percentiles. Otherwise, whether the earnings growth rate was positive or negative had little bearing on stock returns.

We can extend this analysis by investigating the relationship between earnings growth and P/E ratios. Rationally, there should be a strong positive correlation as investors reward high-growth stocks with high multiples and penalize low-growth stocks with low ones. Growth investors have repeated this mantra to explain the extreme valuations of technology stocks like Amazon or Netflix.

The simple explanation is that investors are irrational and stock markets are not perfect discounting machines. Animal spirits matter as much if not more than fundamentals. The tech bubble of the late 1990s and early 2000s is a great example of this. Many high-flying companies of that era like Pets.com or Webvan had negative earnings but soaring stock prices.

Of every 10 stocks you buy, only one or two are likely to be truly outstanding performers. Your goal is to allocate the most capital to your best stocks. Say the market has just entered a new rally and you buy five or six stocks. As the rally continues, some of those stocks will show more strength than others. You might consider selling the stocks that are down the most or up the least, and reallocating the resulting capital to your strongest holdings. 041b061a72