From a historical perspective, the stock market shows significant predictability based on cycles and the valuation of stocks. For instance, tracking the price-to-earnings (P/E) ratio over the past two decades reveals that it indirectly influences future returns (Tall). The explicit implication of this statement is that over the last 20 years, a low P/E ratio provides a precursor to higher returns at the end of the trading period. The opposite also holds true in a trading period where high P/E ratios are documented at the start (Tall).
In addition, evaluating chronological data of the stock market shows repetitive trends influenced by various factors such as prevailing economic conditions as well as buyer and seller behavior. Such an observation means that market cycles run back and forth in successive sequences (commonly referred to as the bear and bull phases) (O’Neil). Normally, an uptrendor and downtrend signifies a bull and bear market respectively. According to O’Neil, normal bull cycles lead to a 160% increase in major indices, which last for three and a half years on an average. O’Neil further analyzes data and discerns that during bear rounds, indices face a 43% decline over a one and a half-year period on average. Consequently, the market phase influences traders in terms of buying and selling decisions, which continue to shape future trading behavior. Summing up, historical data provides excellent insight into stock market trends.
For instance, the discussion above highlights the fact that using past data discloses high predictability in terms of market sequences and changes in stock evaluation. Moreover, such observable and deducible trends have provided analysts with the right tools for examining whether stock prices have attracted reasonable valuations. They also allow traders to select the right approach depending on the perceived risk and expected return.
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