Bull or Bear?

William O'Neil is one of our favorite financial authors and traders of all time.

O’Neil is best known for founding the investment publication Investor’s Business Daily and authoring the book How to Make Money in Stocks.

That book is the best book we recommend to any reader who wants a comprehensive tome on how to really make money in the stock market.

What we appreciate most about O’Neil is the method he used to figure out his process.

He began by looking at the BEST stocks of all time and then worked backward from those. He figured out what they had in common, putting it together in his "CANSLIM" method.

We wrote about the "M" in this method a few weeks ago. That stands for “Market.” You can read that note here.

O'Neil discusses in the book that the underlying stock market environment will determine which types of trading work best.

You can think of it like the weather when sailing a ship.

In general, there are aspects of sailing that you want to keep the same and will always work. Depending on the weather, though, you might want to (or need to) change what you are doing to get where you are going. Or even maybe to survive…

The same can be said for the stock market.

The strategies that work in a BULL market are not necessarily the ones that work in a BEAR market. Those strategies might be the worst ones and lose you all your money.

Understanding the “weather” of what type of stock market you are trading in is one of the biggest keys to success.

How does one know which type of market it is?

The definition of a "BULL" or "BEAR" market is subjective, but we consider them a confirmed TREND.

Markets trend over many months, and the next movement in the stock market is likely to follow the previous movement.

The good news is that we can use technical analysis to help us understand the trends.

We do this by using the “moving averages.”

Let's share the definition of the moving average because people often use them conceptually without thinking about what they really mean.

The moving average is calculated by simply taking the average of the closing price over a time period. The most quoted moving averages are the 50-day, 100-day, and 200-day moving averages.

Put simply, the 50-day moving average is the average price at which a stock has been traded over that period.

We recently wrote about the meaning of the moving averages in a note. You can read that here.

Here is a chart of the S&P 500 since November 2022 with these moving averages on the chart…

Over this period, the stock market has been up more than +50%, so THAT certainly fits the definition of a BULL market.

That is backward-looking and doesn't tell you where the stock market is now and/or where it could be going.

To do that, we can use the moving averages.

We want to see that the short-term (50-day and 100-day) moving averages are trading above the 200-day moving averages.

We would say that if you have a stock market that is up at least +15% from the 50-week low and these two averages are trading above the 200-day moving average, then you are in a BULL market.

What does a BEAR market look like?

Here is the same chart of the S&P 500 from September 2021 through the end of 2022…

This chart shows that in May 2022, both the shorter-term moving averages moved BELOW the 200-day moving average. The S&P 500 was also down 15% from its 52-week high.

This confirmed that the stock market was now in a confirmed downtrend or BEAR market.

What if the data needs to be clarified? Is one of the shorter-term moving averages below the 200-day but not the other? Or is the stock market not up or down at least +15% from the lows or highs?

That is a signal telling you that you are in the THIRD type of market environment.

In this note, we will not dive into the different trading strategies for each environment, but they are distinct.

Be sure you understand which you are TRADING in right now to give you your best chance of success.