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Stock market investors are split into bull and bear camps — taking the middle road is the way to go

In this precarious market, it’s wise to think in terms of probabilities. Read More...

I’m receiving more than the usual number of emails from investors who are concerned about the stock market potentially falling — crashing, even.

They’re referring to well-reasoned articles published in the media. On the other hand, a smaller number of investors are convinced the market is heading to new highs and are aggressively buying technology stocks.

What should a prudent investor do? Let’s explore the issue with the help of a chart.


Please click here for an annotated chart of SPDR S&P 500 Trust ETF SPY, -0.03%  which reflects the S&P 500 Index. Please note the following:

• The chart shows two potential upside targets.

• The chart shows four potential downside targets.

• If you are not already practicing Arora’s Second Law of Investing, consider understanding the nuances: Nobody knows with certainty what’s going to happen next. Not even those with a good track record. In late 2007, we at the Arora Report said stocks were in trouble. Sure enough, about a year later we got a big crash. So you see, even though we were right, it’s exceedingly difficult to get the timing right — there are too many factors at play.

• If nobody knows with certainty, how do you invest? The answer lies in Arora’s Third Law of Investing: Make investing and trading decisions based on probabilities because it’s the only realistic and profitable approach.

• We determine probabilities based on the ZYX Asset Allocation Model. This is a sophisticated adaptive model that has inputs in 10 categories. (Please click here to see the 10 categories.) In plain English, adaptive means the model automatically changes itself based on market conditions.

• At this time, the probability of the stock market reaching the first upside target shown on the chart is 20%.

• The probability of the stock market reaching the first downside target is 30%.

• Keep an eye on large-cap technology stocks such as Apple AAPL, -0.83% Amazon AMZN, -0.18% Facebook FB, -0.17% and Netflix NFLX, +1.02% because of their disproportional effect on the stock market.

• Keep an eye on semiconductor stocks because they provided an early indication of this rally. Stocks to watch include AMD AMD, -0.14% Intel INTC, +0.09% Micron Technology MU, +0.26% and Nvidia NVDA, -0.29%

• Keep an eye on software stocks because they have been the market leaders. The stocks to watch are Salesforce.com CRM, +0.31% Autodesk ADSK, +0.83% Adobe ADBE, +0.12% and ServiceNow NOW, +0.87%

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

The way forward

Many individual investors get in the mode of either being 100% out of the market or being mostly invested in the stock market. At this time, based on probabilities, neither approach is sensible.

Investors should consider staying invested in good long-term positions, holding appropriate levels of cash and hedges. and taking advantage of opportunities that the upcoming earnings season will provide. Earnings season always provides opportunities on both the long side and the short side.

The probability is better than 90% that earnings will reveal slower growth. However, can we predict with a 90% confidence level how the stock market will react? The answer is a resounding “no.” This is why instead of just opinions, investors ought to rely on adaptive models that have a proven track record in both bull and bear markets. Consider staying away from static models because they stop working when market conditions change.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at [email protected].

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