Stock markets are meant to be random and by and large they are, at least, very random.
Its not surprising because if they were not you could predict them to a much better than 50/50 probability and thereby suck all the money out of the market and thereby kill it. We notice equity markets are not dead, so therefore they are pretty random.
Pre-emption is one of the drivers of the random nature of markets.
If you could predict the market by crunching the day to day price levels with historical moves and volume, we all would, and before you know it you would have to pre-empt those moves to get in ahead of others doing likewise. So would everyone else playing the same system. Then the predicted move wouldn’t occur because of pre-emption, so the predictive system would be increasingly bent by pre-emption until it was broken.
You can dig into the time series data yourself and you will be amazed at how few crumbs of stock move fate are there to be traded and ones you find are rare opportunities and mostly tiny. After all there are thousands of bank, hedge fund and market maker maths professors looking for such morsels, so it would be very weird if they hadn’t traded them to dust.
Yet all is not lost, random can be predictable it its own way.
One situation is apt to the current state of the markets.
As you can read here:
I believe we are at the bottom of a range bound market, but the market doesn’t listen to me, so I keep reevaluating, especially when the market drop 400 points like it has as I write.
I would be sad if the market crashed as my current position is to hold.
Generally, market bottoms are W shaped. V shaped bottoms are rare when the scale of a fall is large. A big fall generally creates a period of volatility at the bottom and this creates the classic W. A W is the basic form of the next more complex pattern after a ‘down the up’ shape.
However if that ‘bottom’ is ‘false’ it will fall heavily again.
An initial market bottom is always going to be a moment of maximum danger which is why it pays so handsomely to get it right.
What does the math of random tell us to help us here.
Let us examine a similar model, a situation summarised from Professor Manfred Schroeder’s classic. “Fractals, Chaos, Power Laws.” Imagine you are rowing across a fog filled lake of unknown but randomly size. How long on average to get to the otherside? The answer is, if you can solve the algerbra, you are always, on average, half way across.
That’s an amazing result and very interesting when you think the width of the lake as being the length of a trend. Then you have to imagine a break in the trend, like we have now in this correction, as being the otherside of the lake and/or the moment you ask the question, “how far to go now?”
To me it implies, when a bottom is hit, you are either the whole way there or at some kind of intermediate ‘half way’ point.
As evidence that idea is not crazy, many big moves have breaks in the middle, you can see them for yourself. Trends are riddled with these 50% trend pauses, often nested. Good old fractal geometry.
So right now we can imaginewe are half way along this move or at a bottom of it.
As such we are looking for the W pattern to form now or for the next slump down to 24000.
This look quite compelling:
A W bottom outcome would look something like this, which is not as compelling with no nice tramlines to draw on the trend. (‘Who needs them’ you are free to say.)
This projection is just a flip of the fall to give an idea of what a W bottom would look like. It could be much fatter and spread over a longer term.
Now while I cling to my 200 day moving average theory, the real problem with a breakdown through this level to 24000, is that suddenly the old cliché ‘head and shoulders’ pattern starts to take shape and that has 18000-20000 written on it. This would be a classic crash.
This ‘head and shoulders’ projection is the standard ‘doom porn’ we are all bombarded with in the media. It could happen because of reverse QE, the nose bleed levels of equities in the US and the crazy state of the world today in the volatile new political environment.
But I don’t yet believe in a crash, yet.
So what to do?
Watch and tidy.
When you start to sweat like this, the best thing to do is go through your portfolio and sell anything you don’t remember why you own or no longer fancy. If you have a portfolio of any size there is bound to be some fluff in it. Cash out the fluff by going through every stock and checking up on its progress and your reasons to hold it now. It’s a gentle risk off approach and no one can say you should hold a stock you no longer have hopes for.
As such, we continue to row across the foggy lake of the stockmarket, hoping that this ‘correction lake’ is not too big. It is probably worth chanting ‘Buy and Hold. Buy and Hold’ as we go, but that is not always the winning strategy.