A
new trader quickly determines that in order to be successful,
one must master market predicting. After reading some books
in the conventional literature, he attempts to find repetitive
market patterns and cycles using price bars or mathematical
indicators. He may fall prey to various expensive system promotions.
In spite of the abundance of such prediction methods in books,
systems and software, in the long run, probably 95 percent
of traders lose. Nevertheless, almost no traders question
the proposition that exploitable, repetitive price patterns
and cycles exist.
People
are naturally susceptible to wishful thinking. They believe
what they want to believe in spite of obvious evidence to
the contrary. Shortterm luck causes many such faithful traders
to reinforce their invalid beliefs. Unsuccessful traders have
a distorted view of the markets, themselves and what they
are really doing when they trade. It is very difficult for
them to shed these misconceptions so they are doomed to longterm
failure.
It
turns out that it is possible to examine historical market
price action with mathematical and statistical tools and determine
whether such repetitive patterns and cycles exist. Chaos Theory
is the mathematics of analyzing systems such as market price
action.
Chaos
analysis tells us that market prices are highly random with
a trend component. The amount of the trend component varies
from market to market and from time frame to time frame. Shortterm
patterns and repetitive shortterm cycles with predictive
value do not exist. The patterns of prices and indicators
traders use to predict occur as readily in random data. Thus,
you have about as much chance to predict shortterm market
prices using technical analysis as you do to predict future
numbers on a roulette wheel.
Edgar
Peters examined four years of tick data in the S&P. He
concluded that while shortterm data is not totally random,
the deterministic element is so small as to be barely measurable.
He concluded that "it is highly unlikely that a highfrequency
[shortterm] trader can actually profit in the long term."
He also found that there are no cycles in intraday data.
This
is not opinion. It is scientific fact. Traders who ignore
it do so at their financial peril. Does this mean the markets
are a random walk and that eventually all traders will lose
because of the costs of trading? No. Traders
must exploit the longerterm trend component of stock
market price action to obtain a statistical edge. This is
precisely what trendfollowing systems such as GetFolio.com
do. It explains why good trendfollowing systems traded in
diversified market portfolios tend to make money year after
year while daytraders invariably lose in the long term.
