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From The Presidential Election to Bad Breadth: How to Play Patterns in the Markets

By John Persinos on June 20, 2016

The incomprehensibly vast galaxy Andromeda has the same spiral shape as a tiny nautilus seashell on the beach.

A sped-up film of cars speeding through highways closely resembles blood pumping through human arteries.

And just as you can find patterns like this in nature, you can find patterns in the markets. Below is a snapshot of a few basic investment patterns you should learn to recognize, to beat Wall Street at its own game.

Let’s start with this year’s wild and crazy contest for the White House.

1. Presidential Elections

Who will win the presidency this fall? History shows that Americans usually vote their pocket book. Simply put, if perception at election time is the economy is improving, odds favor the party already in power. That would seem to bode well for the Democrats and their standard-bearer, Hillary Clinton.

What’s more, the broader stock market almost always does well during a presidential election year. Since 1928, only during four election years did the S&P 500 post a negative return: 1932 (-8.2%), 1940 (-9.8%), 2000 (-9.1%), and 2008 (-37%).

These “outlier” years can be explained by singular, extraordinary events: the Great Depression in 1932; the fear of war in Europe in 1940; the bursting of the tech bubble in 2000; and the Financial Crisis in 2008.

The existence of these exceptions to the rule, combined with a particularly risky global environment, indicates that the presumptive Republican nominee (and statistical underdog) Donald Trump could find a path to power. But based on time-tested historical precedent, the odds right now heavily favor the incumbent party.

2.End of December

To claim capital losses, many investors during the final trading days of the year dump stocks that have declined in value throughout the year.

3. January Effect

At the beginning of January, investors return to equity markets with ferocity, pushing up prices of mostly small-cap and value stocks.

4. Bear Market Patterns

The following patterns have consistently warned us of an imminent bear market:

  • The indices continue to rise but the number of 52-week highs begins to decline – If the number of 52-week highs declines, this means fewer stocks are working to push the market upward.
  • The major indices move below a previous “swing low” – Swing low refers to the troughs reached by an indicator or an asset’s price. A swing low occurs when a low is lower than any other point over a certain time period. Successively lower swing lows mean that the underlying asset is in a downtrend; higher lows mean it is in an uptrend.

    When the market is an upward trajectory, share prices hit higher highs and higher lows. Consequently, when prices neglect to post higher highs or forge a lower low than the previous low in the uptrend, the uptrend has run out of gas.
  • Extremely high trading volume and volatility – This symptom enriches brokers and generates a lot of paperwork at brokerages, but it’s often a sign that the market is getting frothy. In an overheated market, brokers tend to churn ‘em and burn ‘em, racking up fees for themselves.
  • Valuations are off the charts – It’s a warning bell when valuations are at historical extremes in terms of price-to-earnings (P/E) ratios, dividend yields, book values and corporate earnings.
  • Bad breadth – No, we’re not referring to halitosis. A sign of a market peak is when fewer and fewer stocks are participating in the upswing. It usually means that the major indices are lurching toward their final climax.

    Specifically, It’s a bad sign if the NYSE advance/decline has peaked and is now declining, even though the S&P 500 and Dow Jones Industrial Average continue higher. This pattern indicates that even though the selective market indices are rising, the much broader market is foundering. It tells us that a minority of companies is driving overall market performance.
  • When “distribution days” are packed into a short amount of time – A distribution day is the term for a down day in the market on heavier than usual volume. When the stock market has a half dozen distribution days within, say, a 2-4 week time period, it means the market is getting very wobbly.
  • The market leaders are losing steam – Bull runs often are propelled by a relatively small number of strong stocks that are “market leaders.” When these stocks begin to falter, it could mean that the rest of the troops will follow.

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