Why we trade the stock market


Trading the stock market is much easier than trading other markets such as forex and commodities because the stock market has a long term, one-way bullish bias. Other markets don’t have this long term bias.

People who tell new traders to start by trading forex are usually brokers who want to generate more trading commissions. In reality, trading forex is much harder than trading the stock market. This is because currency pairs swing sideways over the long term. This is the U.S. Dollar Index. Notice how it swings sideways in the long term.

Since currency pairs swing sideways in the long term, the average currency trader will make zero percent trading currencies. In a zero sum market, the average trader makes 0%.
Hence, any currency trader is fighting against 0%. Remember how probability distribution works: the farther away you want to go from the average, the harder it is. This means that e.g. only 5% of currency traders can average 10% per year, which is 10% away from the average of 0%.
The U.S. stock market is different. It goes up an average of 7-8% per year in the long run. This means that the average trader/investor makes 7-8% per year in the stock market. Hence, any stock market trader isn’t fighting against 0%. He’s fighting against 7-8%. Remember probability distribution: the farther away you want to go from the average, the harder it is. 10% is a lot closer to 7-8% than it is to 0%. Hence, it’s a lot easier to make 10% in the stock market than 10% in forex.
Here’s another way to look at this concept. Here is the random probability of various markets going up on a 1 day, 1 week, 2 weeks, 1 month, 3 months, 6 months, and 1 year forward basis.
This is for the U.S. stock market

*There’s a simple reason for why the stock market has this bullish bias. The economy is improving most of the time (>50% of the time). The economy and the stock market move in the same direction in the long term. Hence, the stock market has a long term bullish bias. 
This is for gold and silver


This is for oil

This is for the U.S. Dollar and Euro


As you can see, the longer the time frame, the more likely it is for bullish investors in the stock market to make money. However, the probability of the currency and commodity markets going up vs. down is approximately 50/50 on every single time frame. This suggests that there is more randomness in the commodities and currencies markets. Trading a market that has a high degree of randomness introduces a greater element of random gambling.
Some people say “I just want to trade currencies/commodities. I don’t want to trade stocks. So if I don’t beat buy and hold, that’s not a problem. My benchmark shouldn’t be the stock market”. In my opinion, that is them fooling themselves.
Buying and holding a S&P 500 index ETF (e.g. $SPY) is the easiest thing you can do. You can do it if you know NOTHING about trading and investing. Just buy it, forget it, and go to sleep. The purpose of investing and trading – no matter what market you trade or what your benchmark is – is to make money. If you’re a hedge fund or professional trader who can barely beat the S&P in the long run, regardless of what market you trade, what you’re really saying is:
I am spending 40+ hours a week in this industry as a professional, and I still can’t beat people who do nothing.
What does that say about your strategy? You’re doing something wrong!

Be more careful when turning bearish than when turning bullish

This is a big problem that many traders face. They are just as likely to turn bullish as they are to turn bearish. This is wrong, becaues it goes against the stock market’s natural bullish bias.

In the stock market, you want to be more selective of bearish trades than bullish trades. You want to be more careful when it comes to turning long term bearish than when it comes to turning long term bullish.  This is due to the stock market’s bullish bias. When most people turn long term bearish, what tends to happen is the stock market first goes up another e.g. 10%, and then it falls 10%. When they say “see, I told you so! I saw it coming!”, the market is no lower than where it was when they first turned long term bearish.
This chart demonstrates the year-over-year change in the S&P 500. Notice how it is positive most of the time because of this bullish bias. Even when the market makes a 10% correction, its year-over-year change will often still be positive. Hence, it’s better to err on the side of optimism rather than to err on the side of pessimism.

One of the members in the Bull Markets Membership Program said “if you are short, keep it short”. Truer words have never been spoken. The longer you hold a short position, the more dangerous it gets because the stock market’s random probability of going up increases over time.

Regardless of what technical or fundamental indicators you use, catching bottoms is easier than catching tops. This is due to the stock market’s bullish bias. The stock market can rally for much longer than you think after you turn long term bearish.
I have noticed this in my model building, and so have others. Catching bottoms is much easier than catching tops. For example, Citigroup has built a Panic/Euphoria Model.
Their model’s disclaimer is particularly interesting.

“Historically, a reading below panic supports a better than 95% likelihood that stock prices will be higher one year later, while euphoria levels generate a better than 70% probability of stock prices being lower 1 year later”.


Notice how Citigroup’s model has a better chance at predicting bottoms than tops. That’s because bottoms are much easier to predict than tops.

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