Why You Need To Trade Direction

Directional Trading

Much has been written about the saturated mutual fund industry, the death of the dividend, and the myth of the earnings yield.

The long-term average annual return on stocks, touted as gospel by certified financial planners and CNBC talking heads, is around 9%.

Most investors don’t realize that these returns factor in dividend reinvestment.

Periodically, throughout the 1950s and 60s, dividends paid 4-5% or more on some stocks.

Today dividends have virtually disappeared.

The death of the dividend was embraced wholesale by the mutual fund industry and enthusiastically replaced with the promise of capital appreciation.

Who needs a dividend in an age of relentless appreciation? Stocks need only go higher. The public was bamboozled… until 2008.

Anyone who understands equity pricing knows that a dividend is the only way to value a stock or company.

In the absence of dividends, shares are worthless.

No income (dividends) is tantamount to no value.

Capital gains are not a feature in financial models of stock valuation.

A market-driven only by capital gain is no different than a pyramid scheme. Continuous, increasing value requires new money and new buyers at successively higher and higher prices.

With capital amounts finite, price stagnation is inevitable.

Sam Vaknin, Ph.D., in “THE MYTH OF THE EARNINGS YIELD”, writes: “This is why current investment portfolio models are unlikely to work. Both shares and markets move in tandem (contagion) because they are exclusively swayed by the availability of future buyers at given prices. This renders diversification inefficacious. As long as considerations of “expected liquidity” do not constitute an explicit part of income-based models, the market will render them increasingly irrelevant.”

Aside from the horrific bear market of 2008, if you noticed that mutual fund returns have stagnated over the past decade, you are correct.

That trend is likely to continue. High fees, inflation, over-diversification, and the disappearance of income will conspire to ensure the underperformance of your favorite fund.

Get out while you can.

Year in and year out, however, small handfuls of promising growth stocks double and triple.

The ticket to double-digit returns is found in the daily and weekly trends of these equities.

Diversification is great if you’re considering various asset classes (stocks, debt, art, gold, etc.).

But equity diversification is nothing more than a shot in the foot of your long-term goals.

The people who sold this notion to the collective American investor neglected to mention that three out of four stocks follow the broad market trend.

Diversity has no place in single asset speculation. But a basket of high-quality momentum stocks that are outperforming the broad market certainly do.

The good news is that the process can be reversed to exploit the downside.

So what is the best plan?

Trade for direction.

Institutions will have a greater and greater interest in price movement as long as the current paradigm prevails. The result – extreme delta up and down.

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