Tuesday, February 20, 2007

Fooled By Randomness

Every so often someone publishes a book proving without a doubt that there are no patterns in the stock market and that people who adhere to the tenants of TA are being "fooled by randomness." The book becomes a best-seller and everyone who is too lazy to investigate the premise on their own goes - see, I told you so.

What I find most incredible about this is that it is often said by people who believe that monthly housing start data actually means something important.

What could be more random than "monthly housing start data"? Or "weekly unemployment figures"? Or "monthly CPI figures"? (Coming by the way on Wednesday). Or "consumer confidence percentage changes"? Or any number of other government reports that economists live and die with?

These reports are absolute crap. Why do I say that? Because each report has a life cycle of exactly one day if that - what shocks the market today is forgotten tomorrow and we are on to something new.

Trust me when I say this - the market goes up and down based on supply and demand - if something is being offered in great quantities with little demand the price will go down and vice versa. The basic principle of economics is that the greater the price of something the more of it will be produced and the more of it that is produced the lower the price will become. And once the price hits some magic place where no one will offer any more - the price goes back up.

That's why when housing starts come out on a Friday and they don't ring some magic chime you get this effect -

Now let me just ask you what do you see in the first three candles of this chart - those of you who answered "an opportunity to make a buck" can sit up here in the front of the class.

You see, what happened was an overreaction to a bullsnot report that everyone knows is bullsnot. Then all of a sudden someone else noticed - wow - a chance to make some money and they started taking the offers. The third candle suggests a "short squeeze" and the opportunity to make some easy cash presented itself.

I wasn't watching housing on Friday - still licking my wounds from last week's beat down - but next time some bad report comes out - start watching the industry or industries that might be affected - maybe you can make a few quid by being "fooled by randomness".

1 comment:


Its easy to be fooled.