home Philosophy and Methodology
My core investment/trading capital market philosophy is based on two main ideas. The first premise is that all human group activity will exhibit the same basic behavioral characteristics as other complex natural system behavior we see (but more often don’t really even take notice of or even think about) in the world around us. That behavior includes:
A general bounding of between two generally consistent historical ranges.
A tendency to always be in directional motion... either be up or down but never static.
A tendency
to revert to mean.
It’s behavior I call an imperfect wave.
What are its rules? It oscillates around a mean broadly, but the oscillations
themselves can be chaotic. The lead
data point in a daily series might spend weeks at the upper historical boundary
only to plunge sharply over the course of a few days. Its travels to the ends are unpredictable.
While the ends may be violated frequently, they are never violated by
very much. And the series will
ALWAYS revert to mean. The range boundaries ALWAYS HOLD over time.
The center of all this wave-like behavior is in the energy our planet receives from the sun. Energy travels in waves. Waves can be of any length or any range magnitude. The only constant is that they will remain in waveform. This energy is both critical to, and essential to each of us. We manifest it every day in virtually every moment of our lives. This behavior is strongly exhibited in the capital markets. Essentially... you have a whole range of different phenomenon… the chief of which is arguably crowd psychology, but including fundamental data, weather conditions, credit cycles, and countless others, all of different sizes and magnitudes and relevant importance, all interacting with one another on our system, to create an entirely new set of wave phenomenon we know as markets. and causing/coinciding with things that are happening. Some waves are seconds long others are of geologic length. Our job as trader/investors is to try and identify relevant sized waves of direction in the financial and commodity markets. We then use the observations of tendencies to position… for the long and/or short term.
The best example of this behavior can be seen in a study of weather data. In looking at departures from normal temperatures over a wide range of time frames we witness tremendous variation in the shape of the graph in regard to duration and time spent above or below average. In other words... they are unreliable and hard to predict. But... the ranges that the data set operates in between are very consistent, and will hold within that range a very high percentage of the time. In spite of a high variability of duration above or below mean, the tendency to eventually revert to the other side is repeated again and again. While we humans may think of ourselves as above and beyond the simple rhythms of nature, such influences are sewn into our very fabric. It permeates everything we cerate... including and particularly... financial markets. We have been evolving under their influences for as long as we have been around. While we have no control over our cyclic behavioral tendencies, we can at least, through a process of increasing self-awareness, become more adept and comfortable at recognizing them. We can notice when our mood is low or high, we can consciously work toward understanding that the emotional condition is temporary, and work through it. Such ability is highly valuable in capital market trading where group psychology and mass emotion play such an important role.
The second premise behind my philosophy is that humans (all of us) will repeatedly anticipate that at times where events reside on the upper and lower boundaries of the range, they will continue that trend far into the futures creating crisis and catastrophe, despite repeated historic precedent for reversion to mean.
Many wonder why frequently a piece of news has no effect or even the opposite effect on the price of a security or financial instrument. The reality is that price frequently leads news. I spent some years working for George Soros and he coined the term “reflexivity” for such phenomenon. Each of us should all assume that the information we receive through the financial press is old and has already been acted upon by investors “in-the-know”. By “in the know”, I mean those individuals with intimate knowledge of key developments that will ultimately effect the market perception and thus price of a security. This is why the large, savvy hedge fund managers are always courting Fed officials, high ranking congressional and administration aides, and corporate insiders. These are the people who know key developments in the very formative stages, long before they become news. CNBC may advertise that the only way to make sound investment choices is to “stay on top of the news”, but the truth is, CNBC actually represents the very bottom of the information chain. To think that any news story about a company gets “broken” by CNBC or any one of the major news agencies is absurd. Company insiders, board members, commercial partners and employees all will, for the most part, have a greater knowledge of what’s going on than someone on the outside. I at one point was looking at $8 Enron shares thinking “they were cheap” but a call to an associate who happened to be one of their trading counter parties alerted me to what he was seeing, curing me of any desire to buy the stock.
In addition and deeper, we all need to understand that “news” is a function of perception. News as published by the New York Times will no doubt have a different spin that news published by the Singapore Straits Times. In the capital markets, it is the evolution of the perceived news into a storyline that drives participants to put capital to work in one area or another. These storylines always get wrung out and over extended, making the markets vulnerable to rebuttal storylines. This interplay creates tremendous opportunity for those whose antenna are up to new and evolving storylines.
Prices for any stock, bond or commodity will ultimately be determined by capital flows into and out of that security. It is not supply/demand, earnings, yield, cap spending, dividends, balance sheet or any of the other commonly watched indicators of company health. Although capital may flow into securities that display favorable characteristics in those categories, the fact remains that even with good statistics, if sellers are more aggressive than buyers, prices will move lower and vice versa. Many times we see securities moving one direction despite news that "should" be driving them the other direction. Markets move to the tune of those whom I refer to as “with the cash”. Obviously this group includes large money managers, pension funds, government controlled investment plans and ultra high net-worth individuals.