Listen to the Market, Not to the Pundits

• ByMark Manning, RealMoney.com Contributor
• On 9:00 am EST, Friday January 2, 2009

2008 will likely go down as one of the worst years in history for markets. This year has probably destroyed more wealth than any other in history. Fortunately, many of the commentators on RealMoney may have helped many readers navigate the rough waters.

I feel especially honored by all the compliments from readers who have emailed me on how they have avoided all the carnage in the market, financial sector and commodities and dramatically outperformed the indices from following my columns. I will continue to work hard to keep readers out of trouble and positioned correctly throughout the coming year.

As we enter into the new year, I want to lead off with an important lesson on how to watch the markets so that you can cut out all the bottom-calling, wild predictions and constant noise from the financial community.

For most investors, one of the most confusing and frustrating parts of investing is understanding the market's ups and downs. Questions surface, such as, "Am I investing too early or too late?" "Is this the top or the bottom?" "When I listen to TV or read the paper, everyone has a different opinion. How do I know what to believe?"

Well, here is your answer:

Believe no one! Listen to what the market is telling you!

The action of the market is the truth everyone else is merely estimating or guessing.

Let me let you in on a little secret that the financial news networks or Wall Street will never tell you: No one really knows what the market or stocks will do six months from now -- no one!

The markets may always be looking ahead six months, but no one knows for sure what will really happen. All you can know is what it has done in the past and what it is doing right now. Knowing what the markets are doing now will give you clues on what will happen next. I know, now you are really confused. If no one really knows, whom do I turn to? As I just said, listen to the market. The market may not tell you exactly what it is going to do. However, it does give clues. What is important is that you know which clues to look for.

Many factors can affect the market. As you know, economists and market pundits quote all kinds of numbers and reasons for the changes in the market. The problem with listening to these people is that they are giving reasons for events that have already happened. That rarely works, because the markets are always looking at least six months into the future. What I want you to do is turn off your TV, quit reading other people's opinions and ask yourself a few simple questions that will give you a good sense of the health of the market. Here is what you need to know to make educated decisions.

• Is the market in a general uptrend or downtrend?

When I say "the market," I am usually referring to the S&P 500. If you are going to follow only one index, this is the best, because it represents 500 companies. The Dow Jones Industrial Average only has 30. I watch the S&P 500, Dow Jones, Nasdaq and Russell 1000 and 2000, along with many other indices and components. The more you watch, the better, because you can see where strength and weakness is in the market.

• On up days, does volume increase or decrease?

On up days, you want volume to increase, and on down days you want volume to decrease. If the index such as the S&P 500 is just drifting sideways, the volume should be low. When the prices move up out of a sideways range, volume should increase. This is a sign of a healthy market. If the market breaks to the downside out of a sideways range on high volume, it could be a danger signal.

If you have several big down days on heavy volume over three to four weeks, the market could be in for trouble over the intermediate term. This is a very important lesson, because when the market is in a downtrend, it will take four out of five stocks with it.

• Does the market open lower in the morning then close higher at the end of the day?

Markets that consistently open lower in the morning and close higher at the end of the day confirm a bullish trend. Institutions will usually make major buying and selling decisions in the last hour to hour and a half of the day. If they are buying at the end of the day on a consistent basis, it is positive for the market.

Markets that open higher in the morning and close lower at the end of the day are just the opposite and could be a sign that the market is overvalued or in a negative environment.

• How does the market react to the news?

It is very important to watch how the market reacts to news. If the market is in a downtrend or a bear market and it no longer goes down on bad news, then you are possibly nearing a low. It is even more positive if you have plenty of bad news and the market goes up. The opposite is also true. When a market continues to drop when all the news is great, watch out!

Finally, here are key points to keep in mind:

• You want the volume in general to be higher when the market moves up and lower when it moves down.
• If the market is moving up on lower than normal volume, be careful.
• If the market averages are trending sideways, then the volume, in general, should be low.
• If the market breaks out to the upside, volume should increase.
• If the market breaks out to the downside and the volume is high, it could be a warning signal.
• If the market has several selloffs on high volume during a three-to-four-week period, you should not be buying stocks.
• If you already own stocks, be prepared to sell if your stocks start to do the exact same thing.
• High-volume selloffs, especially several of them in a short time frame, usually mean the end to an uptrend, whether in an index or stock.
• If the market starts opening higher in the morning and closing lower at night, you should watch your stocks closely and prepare to protect your profits.
• If the stocks that have been leading the market start to fail or break down, you should prepare for a correction.
• If the market goes up on bad news, it a positive. If it goes down on good news, it is negative.

If you just follow the above rules it will dramatically improve your trading and investing in 2009.

I wish everyone a safe and Happy New Year! See you next week.

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Know What You Own: On Wednesday, the most active stocks included the PowerShares QQQ, Microsoft, Cisco, Intel, Oracle, Apple and FLIR Systems.

Buzz up!