The stock market is a mysterious beast to those who do not study it. Correlations between stock prices and everything from the economy to lunar cycles are drawn by those wishing to divine some sense of the movement in stock prices. At times there appear to be very clear correlations between the stock market and another asset class, such as the dollar or US treasury securities. However, in the long-term these correlations invariably break down and leave people wondering why.
The market’s behavior is so confounding that many have subscribed to the ‘random walk’ theory of the markets, which states that price movements in stocks have no discernible pattern. The biggest detractor from this hypothesis is the fact that the stock market as a whole does display price patterns and trends that repeat over and over. The random walk theory was devised before ETFs and index funds existed, so it is somewhat forgivable. However, fortunes are made by the best trend-followers, even in years like 2008. In fact, a fund run by consummate trend-follower John Henry, who is also owner of the Boston Red Sox, was up 91% last year.
The problem with trying to determine why the market is moving a particular way is that it is a fool’s endeavor. There are simply too many factors that affect the market for one to accurately evaluate and anticipate in a given week, month, or year, and much less to do so in a repeatable fashion. In very short timeframes, such as a few hours, it is possible to trade profitably based on news and asset correlations. However, even such short-term trading is difficult, as news and events are now reported and disseminated so quickly that anything not anticipated can ruin a week’s worth of profits in a matter of hours.
Instead of asking why the market is moving as it is, consider looking simply at how it is moving. That is, look at the trend of price movement as divorced from all other factors, and you will have a much better understanding of how to profit in the stock market. The underlying trend for the past 200 years is clearly up. However, there have been periods of significant multi-year declines throughout. In the past decade, stocks have produced about a 0% return before dividends, but the S&P500 rose over 100% between late-1996 and 2007, then retreated over 60% by March 2009. There is ample opportunity to profit during such times, and there will be many more such opportunities in the future.
Stay tuned for a primer on technical analysis tools and how to use them at the appropriate time.
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