Markets are highly random and are very, very close to being efficient.
If you are a new trader, trading is probably harder than you think it can be. If you’ve been trading a while, you know this. Financial markets are one of the most competitive environments in the modern world. New information is quickly processed and incorporated into prices. This means that you cannot outsmart the market consistently. You cannot invest based on what you think makes sense or should happen because you are up against investors with superior access to information, knowledge, experience, capital and other resources. Most of the time, markets move in a more or less random fashion; you can’t make money if market movements are random. (“Efficient”, in this context, is an academic term that basically means that all available information is reflected in prices.)
It is impossible to make money trading without an edge.
There are many ways to create an edge in the markets, but one this is true—it is very, very hard to do so. Most things that people say work in the market do not actually work. Treat claims of success and performance with healthy skepticism. I can tell you, based on my experience of nearly twenty years as a trader, most people who say they are making substantial profits are not. This is a very hard business.
Every edge we have is driven by an imbalance of buying and selling pressure.
The world divides into two large groups of traders and investors: fundamental traders who base decisions off of financial analysis, understanding of the industry and a company’s competitive position, growth rates, assessment of management, etc. Technical traders base decisions off of patterns in prices, volume or related data. From a technical perspective, every edge we have is generated by a disagreement between buyers and sellers. When they are in balance (equilibrium), market movements are random.
- Sellers are in control
- Oversold often stays oversold for a long time
- Markets drop a lot faster than they go up
- Bear markets burn and churn accounts with long only exposure
- Volume and liquidity can dry up but price can still drop significantly
- ‘Cheap’ can get a lot ‘cheaper’
- Hope is slowly destroyed
- Vicious bear market rallies try to suck in traders to trap them
- Expect lots of gaps to the downside
- It takes a long time until market participants throw in the towel
This is appropriate trading behaviour during bear markets:
- Either in cash or short
- Sell the rallies mentality
- Do NOT buy the dips
- Do not even think about going long if you are not an active and experienced trader
These are some of those fundamental and undeniable truths, as I have come to understand them over the course of my trading career:
- Most of the time, markets are very close to efficient (in the academic sense of the word.) This means that most of the time, price movement is random and we have no reason, from a technical perspective, to be involved in those markets.
- There are, however, repeatable patterns in prices. This is the good news; it means we can make money using technical tools to trade.
- The biases and statistical edges provided by these patterns are very, very small. This is the bad news; it means that it is exceedingly difficult to make money trading. We must be able to identify those points where markets are something a little “less than random” and where there might be a statistical edge present, and then put on trades in very competitive markets.
- Technical trading is nothing more than a statistical game. The parallels to gambling and other games of chance are very, very close. A technical trader simply identifies the patterns where an edge might be present, takes the correct position at the correct time, and manages the risk in the trade. This is, of course, a very simplified summary of the trading process, but it is useful to see things from this perspective. This is the essence of trading: find the pattern, put on the trade, manage the risk, and take profits. (more…)
Markets are notoriously hard to read and people see only what they themselves want to see.
Bulls will find reasons why certain stocks will go higher, while at the same time, Bears will find many reasons for the same stocks to go lower.
The seldom-admitted truth is that most of the time, markets exist in some indeterminate state!
The main thing is that you cannot trust consensus and you cannot rely on the “Establishment.”
You can’t find refuge in the herd and you must resist the urge to join the crowd.
Your passion of the moment will most certainly create a disaster over the years!
On the other hand, if you do stick with the following five essential truths, you do stand a better than average chance to invest profitably:
1. Markets are unpredictable and ill-suited to forecasts.
2. Long-term fundamentals are key.
3. Investor emotion leads to volatility.
4. Valuation discipline should guide investment selection.
5. Perspective and patience are always well rewarded.