Trading and investment on facts

Even today I still regularly find myself making assumptions about the future course of the markets that are beyond any rational basis.

Far too often we interpret things on the stock market, create our own reality and wonder afterwards that the actual outcome is completely different.

I think it has something to do with the fact that our brain is constantly trying to bring order to the information chaos in front of us.

Modern brain research has found out that our entire thinking consists essentially of recognizing and changing patterns. The human brain is able to distinguish up to 300 million different patterns. Like a computer algorithm our mind evaluates the information coming in through our senses. In order to carry out pattern recognition in fractions of a second, the information works its way through our experience databases. During reading, circles, squares and lines become letters, which then become words, later whole sentences, until at the end of an article, chapter or book the content is revealed to us.

The challenge in the stock market, however, is that not every piece of information is as clear as a circle or a letter.

In charting, for example, a trend line can be a support on which prices are based and on which they recover. However, it does not have to be a support, because a trend line can also be broken. There is no guarantee that prices will follow a trend line and recover.

So the confusing thing for our brain is that information that we have stored at some point in the past can be right and wrong at the same time.

This would be as if the letter A could also have the meaning B.

This is quite a strenuous exercise for our brain.

To avoid this stress, I invest and trade according to clear rules that have proven to be evident in the past. This helps me to cope with the daily information chaos of the ambiguous and sometimes at the same time correct and incorrect information of the stock market.

What sounds more than logical and reasonable at first glance is often not so easy in practice. Which trading signal is “right” or which investment approach is demonstrably successful?

Empirical capital market research and econometrics have provided some insights in this regard in recent decades, although the results are quite modest given the supposed abundance of available information and market data.

This is because only very few strategies, such as the factor premiums Value and Size in long-term investing, have proven to be stable when examining long time series.

The results are even thinner with short-term algorithms, such as those we use in trading. The longer the examinations are, the more likely trading strategies are to approach an average market return after costs. (1)

In other words: The quality of most trading signals fizzles out in the long-term comparison. (2)

The financial mathematician and book author Nassim Taleb explains why:

“If rational traders discover a pattern where stock prices rise on Monday, then as soon as such a pattern becomes apparent, it is likely that it will be offset by market participants buying stocks in anticipation of that event on Friday. There is no point in looking for patterns that are obvious to all market participants.” (3)

James Simons is considered a luminary in the field of stock market models, having generated positive returns every year since 1982 with his Renaissance funds.

Simons describes his philosophy:

“Efficient market theory is correct in that there are no gross inefficiencies. But we look at anomalies that may be small in size and brief in time. We make our forecast. Then, shortly thereafter, we re-evaluate the situation and revise our forecast and our portfolio. We do this all day long. We’re always in and out and out and in. So we’re dependent on activity to make money. (4)

Among these short-term anomalies, the so-called momentum effect has proven to be stable. (5) In principle, this strategy is only about following the current price trend. Indeed, capital market research has established that shares with the highest or lowest yields over a short period of time continue this yield trend. As a trader, you can therefore gain a small advantage by recognizing these anomalies and betting on their continuation.

In a word, you could say that when prices rise, you should buy and when prices fall, you should sell.

“The market is going to go where it is going to go.”

  • Eli Tullis (mentor of hedge fund billionaire Paul Tudor Jones and former commodity trader at the New York Stock Exchange)

How such a strategy can look like in trading practice, I will show in my 5-day online coaching, which will take place next week from 10.07. – 14.07.2017, and trade together with the participants.

My conclusion:

In order to cope with the daily flood of information on the markets in the form of prices, news and signals, I need clear rules according to which I buy and sell on the exchange. This fact-based approach frees me from the unsatisfactory task of “oracle and interpretation” and gives me the security to invest my capital in advantageous strategies.

However, the only small and short-lasting advantage of trading tactics also shows that one’s own success is decided only to a small extent in the technical field and that other factors, such as focus or discipline, have a greater influence on victory or defeat on the stock exchange than is generally perceived.

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