Predicting Market Turning Points by Martti Luoma, PhD, and Seppo Pynnönen, PhD
Follow The Leaders
Predicting Market Turning Points
Here’s a unique look at how you can
identify market turning points.
Identifying the beginning of a trend or foreseeing
when a trend is about to start is on every
trader’s wish list. Being able to do this would
help optimize the timing of when to shift from
stocks to cash and equivalents ahead of bearish turns,
and from cash to stocks ahead of bullish turns.
Predicting market turning points will always be a
topic of interest among traders and investors. It will
remain a challenge and will never be completely
achievable. However, in order to gain some ability
to anticipate potential turning points in a prevailing
market trend, it is helpful to identify the processes
that affect these trend turnings.
Is volatility a good measure of risk?
Typically, at the end of a bullish regime, investors
start to reexamine their risk exposure in stocks. This
decreases the demand of the stock at current prices.
The supply increases, exceeds demand, and prices
start to fall –– and markets turn bearish.
This may lead you to think that monitoring market
risk measures is the key to anticipating turns in
trends. But risk is an elusive concept and difficult to
capture. It is usually measured by subjective means,
often by volatility calculated from daily returns. But
using volatility as a risk measure can be a problem
because it gauges variation in stock prices. Hence,
critical risks may not show up in the amount of volatility,
even if the markets have priced in the risks.
Risk, theoretically, is associated with the probability
of an unpleasant outcome (potential losses themselves
are called risks). But probabilities are not visible
in real life. They can’t be observed until they are
realized in concrete terms such as monetary losses.
Because volatility cannot fully capture the invisible
probabilities, simple risk monitoring by volatility is
not adequate to anticipate market turnings. It is better
to turn to other tools.