Wednesday, September 14, 2011

Investing Time Horizon

The Process
The purpose of this post is to express my belief that markets go through a repeating process which results in the achievement of new highs and lows.  While this process does not exactly replicate itself, I do believe it falls within certain parameters.  Allow me to explain why this is important.  For those who think the markets act in some random fashion, what I am about to say will be of little consequence.  Such people are better served averaging into the markets over long periods of time.

The Neatness In Theory
Elisabeth Kubler-Ross popularized the notion that people experience different emotions when confronted with the fact they are about to die.  To her, it seemed there were a number of stages that people would experience, sequentially, one after the other.  While this was a convenient method for studying the process of dying, not everyone agrees those stages are so neatly ordered and labelled.  Few identify the end of one stage with the beginning of another.  Not everyone experiences every stage.  Still, I think most people, today, recognize this as a process, rather than a single event.

For many people to believe the markets follow some sort of pattern, requires that we identify a particular sequence of events that would indicate what was about to happen next.  Few would look to the occurrence of a combination of events, some or all of which would suggest what is to follow.  Surely, for a pattern to exist, at least one event could be identified that we could rely on as a signal of a top in the market, or as a signal of a bottom in the market.  Otherwise, how can we call it a pattern?

I love to use the example of a toy that was popular when I was a child, called the Spirograph.  Using it, we can produce intricate symmetrical designs by repeating certain simple processes over, and over again.  Instead of following the exact process each time, if we introduced a slight variation of the size or shape of the inside disc, or the outside ring, as we went along, a pattern would emerge, but it would no longer be symmetrical.  In other words, it would not be the same each time.

The most interesting thing, to me, is these variations of a theme (in the markets, and in nature), when combined, create a larger version of the smaller design.  These are known as fractals.  Breaking a fractal apart creates a smaller approximation of the larger one, not just a piece of it.  Fractals are abundant in nature: crystals, flowers, lightning and land formations, to name a few.  It is my belief that fractals represent the way things grow.  Markets are a reflection of how society grows economically, technically, and financially.

The Buying & Selling Process
If we believe the markets are an expression of the process of growth in society, and not just some random series of events, then there are a couple of important distinctions we can make.  First, successfully investing in, or trading stocks requires that we follow a process.  Buying at random, without any intention of selling, is an event. Buying with the intention of later selling at a higher price, becomes a process.  Buying at random with the intent of later selling at a higher price is purely speculation.   

Second, an investing methodology should be scalable.  Due to the underlying nature of markets, we can use the same processes when day-trading as we can when investing for years at a time.  The difference is in how we aggregate the data.  We can look at charts of minute by minute ticks, or we can choose charts of monthly price data.  We can look at the change in fundamentals on a quarterly basis, or over periods of years.  In either case, the process remains, basically, the same.

Bottom Line
This is our edge.  In order to outperform most other participants in the markets, I am suggesting we need a process, one which is scalable to the time frame that suits our interests, and needs.  If we only want average returns, or worse, then little, or no action is required on our part.  People who don't know these things to be true will tell you it can't be done.  Don't rely on their saying so, just because they don't know how, or are unable to.

Do you know of a scalable process with which above-average stock market returns are possible?


  1. Ian... I'm so glad I found you... I was looking for your email, but didn't see one? Anyway, about this article... I think patterns are easy to see once they are formed. The challenge remains "predictability." I have not found any reliable way to "predict" the markets or individual stocks; however, I have found that I can be "prepared" for whichever way the market turns or an individual stock, and still be profitable as a result. My Weekend Investor Strategy and Evening Investor Strategy are based on the same principles, but scaled differently due to time horizon and a little bit of risk differential.

    I'd love to see a concrete example of what you are discussing here... Cheers!

  2. Thanks for your comments. I think the best way for me to illustrate what I am saying is with my last trade. I can’t really cover everything here, so I will post the chart from that trade (hopefully Monday) with an explanation. Nobody I know can predict the future. What we can do is wait for the odds to be in our favour based on historical trends. The basic market pattern I follow is described by the Elliott Wave Theory. While I struggle in my personal attempts to make it predictive, understanding what it means allows me to increase my probability of success with more conventional fundamental and technical analysis. The scalability of the fractal patterns which the Elliott Wave is based on allows us to use the larger pattern to place limits, or targets, on the smaller pattern. These patterns and probabilities are highest in the largest aggregate (as with any statistical sample). That means all of the stocks from all of the stock markets combined as one group would be the most predictable, and the smallest of penny stocks, the least. That is why I choose the best companies in the best sectors of the best markets when they are, historically, mispriced - simply, a higher probability of success. More in my next post.


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