Managing risk is the most significant element to successful investing in the stock market. Here's how investors who understand how the stock market works avoided a huge decline in energy stocks.
The financial markets are driven by big investors. In the stock and bond markets, it's primarily mutual funds and pension funds. When you recognize what their investment stance is you can presume it isn't likely going to change in the short run. Of the few investment cliches worth anything, "the trend is your friend" is a good one!
The key to recognizing the severity of the condition in oil and gas and energy stocks, was revealed in the first leg down. Using the chart below, we can see how this energy stock fell. There are several characteristics of the decline, primarily;
- no attempt to rally
- prolonged period in the decline and
- the depth of the decline.
The percentage loss is the most significant characteristic as most energy stocks, including Apache (APA), fell a very long way. This matters as it shows big investors had little interest in coming back into the market regardless of the depth of decline. They were effectively heavy sellers for months even as prices continued to carve out substantial losses from the mid 2014 peaks.
Understanding the stock market starts with recognizing extremes in power. A big decline is likely to be followed by more selling. This is precisely what happened with energy stocks as another round of selling started May 2015. You can see it in the chart below marked by B.
Notice how the break down is equally weak to the first leg down in the overall downtrend. Since mutual funds and pension funds can't unload their entire position in a short period of time, they tend to follow up later.
The chart below shows the long term downtrend from the peak in early 2011. A sell signal was apparent in the summer of 2011 as an attempt to consolidate failed. Notice how the selling at that time was very heavy and defined a clear change in behaviour by the stock and investors in the stock. Typically, the action is similar throughout a sector as was the case with energy stocks.
There was no follow up buy signal in energy stocks. You can find periods when there are rallies, but energy stocks were laggards compared to other stocks and sectors in the stock market. Weak relative strength is a significant tip off to what comes next.
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