How to understand the stock market

Technical analysis, balance sheets and income statements, research reports, CNBC and BNN and the latest news. Many believe these are the ingredients for managing real money in the stock market. But is it?

You'd think with the amount of information on the internet alone everybody would be doing great with their stock portfolios. But who's actually getting ahead of the crowd?

There are literally thousands of books on how to invest in the stock market. However, most books are designed to sell by giving people what they want to hear, not what they need. They inherently make people feel better so they may justify the shortcomings with their stock strategies.

What does it take to succeed in the stock market?

In our investment workshops we typically arrive at a point in the session(s) when something happens. As participants dig in with the content there is an increasing amount of energy, openness, questioning and ultimately resistance. It is critical resistance emerges as without it learning can be cut off. Here's what happens next.

Related: Behavioural Finance. It's about how you deal with it.

How do you know what works?

Consider this hypothetical scenario as we do in classroom workshops and online webinars; "What if you were presenting your investment decisions(s) to Warren Buffet? How would you back up your reasoning?"

Now we arrive at the ultimate question underpinning everything in the investment process. "How do you know"? What is the evidence that supports a methodology, a strategy and ultimately the buy and sell transactions?

If we put bias aside we can see the stock market may be analyzed with science utilizing analytics or metrics that translate into a decision making matrix for every situation. But there's more.

Connecting an investment portfolio to the markets

The stock market is driven by people, not machines, not earnings, the news or some other variable. All of these factors may be part of what somebody uses to make a decision but ultimately the market is about investor behavior. Accordingly, there are patterns and recognizing the patterns is the key to superior strategy and trade execution. It works.

Here are some keys to investment success that we'd like to see everybody work with.

• Timing matters. If it didn't everybody would be rich already.

• It's all about math. It's not subjective, it's not personal.

• Risk management is the most important strategy at all times. Our observation is many retail investors (individuals) are taking far too much unnecessary risk and often don't realize it.

You can do it too. See how.

How you knew Bitcoin would go lower

Leading cryptocurrency Bitcoin has hit a new low plunging 70% in just six months. Unfortunately many eager investors have suffered big losses but there's good news. Here's how you could have predicted cryptocurrency markets were in a significant correction.

It's easy to say a market or security, like a stock, with a big long term gain would suffer a huge loss. But that's usually fear talking rather than the recognition of how markets play out. Investments with big gains are how you make money but when the tide turns you need to know when to get out.

All markets are the same!

Behaviors in a market or security provide far more information than alternatives. After all, how money is moving around determines the net impact in the price trend. But how would you have known to avoid cryptocurrency markets like Bitcoin and Ethereum?

Using the price chart below let's look at Bitcoin and see how indicators, in real time, were a tip off to timing transactions with real money.

The peak is at nearly $20,000 U.S. in December 2017. You don't know that's the peak so let's work through what happens after keeping in mind the market had been performing well above average, out pacing alternatives including the U.S. stock market.

See how the price dropped, in a straight line with no bounce, from the peak to just under $12,000. Some would argue that this is a bull market correction and not a bear market correction as strong markets can have quick sell offs only to recover and march to new highs. But large declines, by nature, are a warning shot as the ability of a market to recover is severely tested. To get back to the high is a gain of approx. 65%. That's a lot!

As the market attempts to rally from the $12K low it stalls at approx. $16K, then drops and retests the low. That's strike two on the market as this is the second significant setback. Think about market sentiment, in real time, as investors are unable to profit or counter losses. But the market ultimately rallies from the $12K low again jumping over $16K getting to about $17K. That price isn't much better but it puts the market in position to advance the recovery and eventually test the old high. The problem is it fails. Notice how price drops back below $16K. Strike three!

Then it gets worse. Early in 2018 the market undercuts the $12K low and it does so in a hurry. It also fails to hold the recovery a few weeks later. The rout is on!

Interestingly, the sell signal came early in the December 2017 decline that started the bear market in cryptocurrencies. It was there in real time!

For indications on market behaviors use the real time research based on decades of analysis of all financial markets.

Top 5 reasons why investors should be wary of companies going public

Companies that trade on the stock exchange have the persona they've hit the big leagues. But there are reasons why companies become publicly traded and they don't all work for naive investors.

Let's look at how the stock market functions so we have context for public vs. private markets. Think of a stock exchange as a shopping mall where all possibilities can be found in one place. It's organized and convenient with the benefit of oversight through securities laws and exchange rules. Associated with the listing is a distribution network known simply as the investment industry where investment dealers work with companies to raise capital through their base of Investment Advisors.

In theory, the primary reason companies go public is to raise capital.

Advantages of going public

Attract talent by offering an added pay incentive through a share purchase plan.

Increase enterprise value through the valuation mark up associated with publicly traded companies. The average multiple in the stock market is approx. fourteen meaning the stock reflects a price that is fourteen times earnings. A company earning say $2/share would trade at $28/share. Higher growth companies can trade at significantly higher multiples. A private company might sell for one to four times earnings.

Exposure through the public market provides companies with visibility and a process for being taken over.

Management of publicly traded companies typically use stock for buying other companies rather than cash. It's their currency for building the business with no impact on company operations.

What to watch for

Going public offers private company investors the liquidity event to cash in. Take the April 2018 I.P.O. (initial public offering) by Spotify (SPOT). Sony, who invested in the company while it was private, was able to sell a significant portion of a large dollar investment into the market. Companies undergoing long term growth can still see their share price increase but others may wilt as initial buying becomes exhausted.

Company founders use the public markets to leverage seed capital as well as financings to increase their personal wealth. Exploration companies (oil, gold, etc.) are notorious for this as naive investors fail to recognize the facade of hype with the reality of the company's capital structure and market cycles.

Valuations for resource companies shifting from exploration to production tends to drop. Ironically, as the company generates revenues and earnings the share price may fall considerably.

Publicly traded companies may have extensive research available providing investors with an information source that private companies wouldn't have. But a sell recommendation is rare as investment dealers are unlikely to receive lucrative investment banking business from a company whose analyst has a negative outlook. Furthermore, analysts are using traditional analysis processes without incorporating the realities of the stock market.

Publicly traded companies may offer a significant amount of stock options to management, consultants and advisors. In larger companies with growth it can work but smaller company capital structures can become overwhelmed from significant overhead.

When the stock market is strong I.P.O.s tend to out perform. But when the market is weak newer companies tend to suffer from the heaviest selling.