A rally in a stock or bond market is not different from a rally in a baseball game. Things go from quiet to exciting, and for a variety of reasons.
Imagine watching a slow ball game. It’s the fourth or fifth inning with no score.
Suddenly, one side begins to load up the bases. Then someone cracks a base-clearing home run!
The team suddenly scoring after many innings of no change is experiencing a rally.
It’s hard to say exactly what has changed. Maybe the opposing pitcher is getting tired. Maybe a couple of base hits inspired the rest of the batting order.
Maybe the team began to worry about losing by a single run late in the game. Whatever the reason, a rally took hold.
In the investing world, stocks usually go up in value steadily, what traders call “climbing a wall of worry.”
There’s no great news. Things seem mediocre in the economy. Political upheaval seems imminent. The drumbeat of war on a distant shore hangs over the market.
Yet stocks go up, inch by inch, day by day.
Then, suddenly, stocks start to fly higher. Nothing has really changed in terms of the news — it’s the same old ball game as before — yet the buyers are showing up in droves.
Often what drives a rally is simply a few large investors deciding to reallocate funds. It could be due to a string of better-than-expected earnings reports.
It might even be bad news that doesn’t seem so bad: A Federal Reserve decision to keep rates steady when a rate hike was assumed, for instance.
You don’t need a bull market to have a stock rally. Sometimes when stocks are in a bear market, falling sharply over weeks, investors can tire of the declines and bid stocks back up.
That’s called a “bear market rally” and they’re not uncommon in down markets.
The important question to consider here is if you should, as a long-term investor, pay attention to rallies. The simple answer is “no.”
Since there’s no real reason for a rally to begin there’s also no reason for one to continue. The risk for most stock investors is buying into the rally as it peters out.
Buying in at a rally peak can lead to remorse and the urge to sell. But that sell decision might also be a mistake. Often, a sell decision comes as stocks bottom.
Buying high and selling low is literally the opposite of your goal as an investor. Rallies (and corresponding slumps) can lead you into situations where emotions rule. Emotional trading creates risk that’s unnecessary and often costly.
Instead of buying on price or the perception of an increasing market, buy a dollar amount of stocks. Called dollar cost averaging, this approach ensures that you buy stocks at an average price that’s usually lower than most people get, because you buy in an unemotional state.
You will sell later, usually decades later, in an equally emotion-free state: Because you need income in retirement, not because a stock you bought decades before has gone up or down in the short run.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.