The resumption of the global risk-on rally late Tuesday illustrates how trends work in the financial markets.
Trends are defined by the time-frame. For example, a market can be bullish in the short-term, bearish in the medium-term, and bullish again in the long-term.
Moreover, trends are never linear, meaning they’re always interrupted by smaller counter-trends.
Currently, global risk assets are in a medium-term bullish trend, driven by modest growth in the developed world and strong growth in emerging market countries.
It was interrupted last week because the prior risk-on rally just became overextended. The short-term decline that ensued culminated in the sizable sell-off on Monday, April 18, when S&P cut its US credit rating outlook to negative.
By late Tuesday, however, the market had turned around and the medium-term risk-on rally resumed.
Some pundits attribute the turnaround to the stellar earnings reports from Intel (NASDAQ:INTC) and Yahoo (NASDAQ:YHOO). However, the risk-on rally started before these earnings were reported and merely received a boost from them.
What really happened was that the short-term decline took the market too low; the medium-term bullish factors then kicked in and the market bought oversold securities.
Traders must always realize what the market should do given the prevailing fundamentals.
Currently, the market shouldn’t suddenly turn bearish in the medium-term because the global economy – either in the form of government policies or economic data – hasn’t materially changed. The decline last week was therefore bound to reverse sooner or later.
Similarly, the prior rally that started on March 17 shouldn’t go on uninterrupted much further because the global economic growth rate hasn’t materially accelerated; sooner or later, market participants will book profits and cause a sell-off.
Long-term traders largely ignore these short-term fluctuations and focus instead on getting the big picture right. Short-term traders also need to understand the big picture. In addition, they need to rely on a combination of technical analysis, market sentiment, and past experience to play the short-term trends right.
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