Monday, May 18, 2009

Serendipitous Joyriding

ser·en·dip·i·ty - the faculty or phenomenon of finding valuable or agreeable things not sought for - Merriam Webster

When looking at the last article, especially if you've tried to delve into technical analysis before, you may have noticed a paradox that's rather hard to overcome. Different types of technical analysis can lead to conflicting conclusions. Different trading patterns can exist simultaneously, even nested patterns. Yet as a technical analyst you would nonetheless be faced with the need to reach a conclusion in the absence of definitive indications. Isn't that what the stock market is supposed to be about anyway? This article aims to change your mind.

Back to clouds and general inaccuracy of weather forecasting, there are some obvious similarities with the stock market. Hurricanes don't just disappear and stocks don't trade at prices that are not supported by supply and demand. The unlikely happens. The impossible doesn't. A hurricane is a very good example of where something chaotic, weather, gives birth to something that's more stable, self propagating as long as conditions remain favorable, and has readily identifiable order to it. Compared to relatively random puffs of clouds that can occur under a lot of conditions, a highly organized storm has both predictability and easily recognized patterns to its behavior. Yes, we still wonder whether they will land in Mexico or Louisiana sometimes, but compared to weather in general, a hurricane is something altogether different than the apparent randomness it resulted from.

Now, to borrow another example from fluid dynamics, take a good look at the photo on the right. Notice how the surrounding clouds seem to have nothing particularly important about them, while seemingly out of nowhere a double swirling pattern emerges and flows downwind. It's a Von-Karman vortex sheet. It was caused by an island that disrupted the cloud flow, which happened to be moving the right speed past an island of the correct size. All of that just happened. And yet the swirl pattern that emerged was periodic, highly organized but still so completely fragile that it slowly dissipates into the equally impressionable surrounding flow.

If chaos is apperent disorder from which it would seem nothing can become ordered, serendipity is the coalescence of many disordered influences that becomes itself not only ordered, but ordered in such a way that it becomes self-sustaining to an extent. As a technical analyst, this is many times what you see. At certain times it's as if there just is no clear pattern, and then out of nowhere the right influences start developing such that there is a clear pattern, and it goes on to re-express itself in the trading behavior as the rest of the traders recognize that the pattern has formed and seek to capitalize on it, reinforcing it.

In the last article, it was advised to think a bit like a single at a bar. Find a table, and then start talking. If you stand out in the middle of nowhere, you're never going to get anywhere. When you're trading, you have to realize that whether you're thinking that a stock is profitable or not, there's still no point in throwing all your money in right away. Don't fight the rugby pile at mid-field.

This article has a second piece of advice; don't find answers where there are none. It's a bit like trying to get inside a person's head while talking to them. You'll inevitably wind up chasing shadows; you'll show yourself in plane sight the first time you screw up. Stock market is no different. The first time you reach a conclusion about something that's really still too weak of a pattern to have the kind of significance required to become self-sustaining, you'll get caught with what's called a whipsaw, where an indicator indicates too early. In layman's terms, it's wrong.

When doing applying technical analysis or any kind of analysis for that matter, avoid the clouds. When you see a small eddie in a vast flow, let it go. When you see a couple of massive vortices that dominate the flow behavior and will continue to do so, jump on it. First of all, the smaller votices are not worth a lot because, even if they do continue to propogate, the end movement will be very small. Second of all, less organized phenomenon always get creamed and negated by more organized phenomenon. Why get fascinated by a quarter that's spinning on a table when a dump truck is about to unload a heap of cash somewhere else? Even if you find a needle in a haystack, it's still just a needle.

Just like these Von-Karman vortex sheets that span miles out over the ocean, what you should be most interested in is that effect that has sprung forth from a medley of all the right circumstances and is about to go on repeating itself several times even in the face of smaller eddies and disturbances along the way. They're huge. They're easy to identify. They develop slowly. They dominate. When you're looking at the weather of the market and the clouds seem to be just rolling forth without purpose, leave them alone. Wait for those moments of serindipity when you realize that all the right things have come together. At that moment, you'll be at the right place at the right time and be able to slowly buy your way into a position, and you won't find it that stressful. You'll have plenty of time to watch and see if the thing keeps developing and you won't have to overexpose yourself by trying to get the most out of a 2ft ladder.

When you do this, it's like your on chaos highway without a thing to lose just changing lanes at a whim and hugging the corners to feel the edge. There are sometimes cars all around and no clear direction, but sometimes that one driver slows down and that one space opens up in that other lane and you can punch it and move straight on through like there's no traffic at all. It's not magic anymore than finding a door in a wall. When it's there it's there. Serendipitous joyriding.

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