Financial markets are highly complex.
I tricked several hundred conference attendees into agreeing with me on that statement last November.
And then I told them: “Just kidding. Markets are simple.” (Making what some would consider the biggest gamble of my career.)
Sure, it was a gimmick to grab their attention from the start. But that belief — that markets are simple — is also a fully sincere explanation of how I view them… from the perspective of a trader, at least.
This coming October — wow, just three short months from now! — you’ll have the opportunity to hear my perspective on what it takes to be a consistently profitable investor, regardless of whether you believe markets are simple or complex.
All you have to do is add yourself to our attendees list for our Second Annual Dent Research Irrational Economic Summit, which we’re holding in the beautiful Loews Hotel in Miami Beach (the location alone being r n enough to join us, if you ask me!)
Still, I’ll give you a quick preview today…
To be clear, there are thousands… if not millions… of factors that affect how the prices of various stocks in the market move. So in that sense, the market is highly complex.
Yet, as I told attendees last November, the mind-boggling number of “input” factors can be reduced down to just two — yes, TWO — “outputs,” when you examine the price patternrns of any stock.
Said another way, there are only two components of price.
One: a cyclical component.
Two: a trend component.
And, well, there’s also “noise” — the unexplainable and spurious flickering of prices that are, in the long-run, best ignored.
So we stay focused on the two main components of price: the cycle and the trend.
While some investment methodologies exploit characteristics of both components, it’s not typical. Instead, the vast majority of trading and investment strategies fall into one of two buckets. They either trade with the trend. Or, they trade against the trend… in anticipation of the trend ending due to the cyclical forces acting on it.
I won’t tell you explicitly which camp I’m in. You’ll have to join us in Miami Beach this October to learnrn that little gem, but I’ll give you a hint by sharing the challenges of anticipating cyclical turnrning points.
First, here’s an illustration of a hypothetical “cycle”:
This ideal cycle is what sits in the back of the minds of traders who attempt to trade against the trend. As prices rise, they envision a cyclical peak nearing and they itch to sell in anticipation of the upcoming downswing.
Or, after a stock has fallen they picture the trough of the ideal cycle, and they feel the urge to buy in anticipation of a cyclical upswing.
The only problem is… stocks, and markets in general, very often fail to even remotely resemble the consistency and regularity of that ideal cycle.
As I shared with attendees of last year’s conference, there are several challenges to trading cycles, or “mean-reversion” strategies, as they’re often called. Here are a few:
• Market cycles are often of irregular period – that is, the number of days from one peak to the next is highly variable. Sometimes it’s 10 days… sometimes it’s 30 days.
• Market cycles are often of irregular amplitude – that is, the price change from one trough to peak is often much different than the price change from the next cycle’s trough to peak.
• Market cycles are subject to trending averages. Meaning, even if a stock “trades cyclically,” rolling up and down, the net movement of price over a long period of time might still trend higher. That makes the short-selling side of trading cycles particularly difficult.
Finally, I’ve done extensive research on market modes – basically, breaking the market down into two modes, depending on whether it’s trading in a trend, or trading in a cycle.
What I found is that the market spends more time in a trending mode than a cyclical mode. And, prices move a greater distance during trending phases than they do during cyclical phases (even when you add up all of the cyclical moves).
I wonder, at this point, if I’ve failed miserably at masking which type of investment trading strategy I’ve found to work best. Regardless, I hope you’ll STILL join us in October so you can get the details of my strategy, which to date has yielded a 75% win rate!
See you there.
|Follow Harry on Twitter @HarryDentjr|