Hope is Not an Investment Strategy

In the last two weeks the Dow Jones Industrial Average surpassed the previous high of 14,164 set back in October 2007. While some rejoiced the milestone with cautious optimism, everyone was already asking the big question: What happens next?

Not surprisingly, there are two schools of thought on the future of the Dow. The doom-and-gloom strategists are predicting a drop of somewhere between five and 50 percent. That’s some room for error, no?

On the other end of the spectrum, optimists feel the economic forces of positive change are here to stay and predict the next stop for the Dow could be 20,000. If you look hard enough you can probably find a few “expert” forecasters anticipate the Dow reaching 30,000 or even 35,000.

While the dramatic range of predictions(50 percent to the minus v. 100-plus percent to the good) clearly illustrates the lack of science to investing, it doesn’t offer much guidance as to what to do next. While you can certainly pick a position, setting your portfolio accordingly, and cross your fingers, I prefer a strategy that relies on more than just hope.

Both adaptable and relatively easy to do, trend following isn’t based on predictions or forecasts. Instead, trend following uses technical analysis of market prices. The idea is to look at moving averages to determine the general direction of the market.

When you see a trend you like, you jump on and stay on until the trend changes. When the trends break down and turn negative, sell and move on.

Thanks to the Internet, it’s easy to track major asset classes and watch trends take shape. Simply set up a basic spreadsheet and start tracking and trending. Start with the prices of the US large cap, mid cap, small cap, and an international stock index. Then throw in what the 50- and 200-day moving averages are for the SP 500 and Dow Jones. For bonds, track short term, intermediate and long-term Treasury bonds and a corporate bond index. All in all, we’re talking about less than 15 stats to track. Once it’s set up, update your sheet once a week, watch the trends take shape and adjust your portfolio accordingly.

The suggested indexes are just a starting point. Over time — and with some self-discipline and practice — you’ll learn how to interpret the data and expand your list. As you refine your process and statistics, you’ll be able to adapt as trends change. Before you know it, you’ll have developed a real-time strategy based on process and experience. And that’s not just hope talking.