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Friday August 14, 2009 - 12:50:50 GMT
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Getting back to the trend instead of intellectualizing…

Key News

Hong Kong's economy broke out of a yearlong recession in the second quarter. (AP)

Before I had studied Zen for thirty years, I saw mountains as mountains, and waters as waters.
When I arrived at a more intimate knowledge, I came to the point where I saw that mountains are not mountains, and waters are not waters.
But now that I have got its very substance I am at rest.
For it's just that I see mountains once again as mountains, and waters once again as waters.

FX Trading –  Getting back to the trend instead of intellectualizing…

We didn’t publish Currency Currents yesterday, as it was a day of trying to get the head right.

To do that, I usually re-read some of my favorite books about trading. One I particularly like is Zen in the Markets, by Edward Toppel. I have talked about this book before in these pages.  The author cuts right to the chase in this book. He clearly shows the battle for trading success isn’t with the market; it is a battle against our ego.   

The basic premise of the book is “you never know what the market will do,” and the best you can do is follow Mr. Market. Therefore, if that is the best you can do, then you should only believe what you see, not what you think. It’s the thinking part which gets us into trouble.  

Mr. Toppel provides a few major examples of thinking vs. what was seen and how many players’ lost money or left a bunch on the table by not staying in the moment of the trend, including: The powerful US bull market rally following what was believed to be the world-ending 1987 stock market crash. The Mexican peso default in the summer of 1982 led many to believe the budding bull market would be derailed and hurt the US economy.  It didn’t and the market continued to soar. My favorite example was the popping of bubble in Japan in the early 90’s; strategists thought it would roil markets everywhere—again it was barely noticed.

Could we see China’s stock market crumble and it have no impact on other world markets? Why yes, even though we have thought it would be the touchstone indicator that triggers risk aversion across all asset classes.  

The problem with thinking risk aversion will be triggered by a Chinese stock market crash means need two things need to happen for it to prove true: 1) It does happen, which is no guarantee, and 2) Aristotelian cause and effect analysis proves correct, and risk flows across global markets. Thus, forecasts (guess) and effect (never a guarantee) need to be right.  Toppel has already shown that even if the forecast is right, the effect is always a whole nother kettle of fish, as my fine English mate often shares with me.

Thus Toppel’s point, by staying in the now moment of the trend (judged by prices going up or down), it is much easier to do right—there are fewer things you need to get right, thus your probability of success rises.  

Often quaint market “truisms” can prove trite and self-serving, proved only by cherry-picking past events to prove one’s point—granted. But I think by at least thinking about this methodology helps put our expectations into better perspective.  

And that perspective…

1)    If you take trades in-line with the trend your probability of success will increase
2)    Accept the market IS right about the trend (because we can see it and riding it puts money in the account; no better proof than that).  
3)    The trend is measured in the time-frame you are most comfortable trading.
4)    Stop getting caught up in the intellectually appealing cause and effect trap
5)    Buy high and sell higher, sell low and sell lower (because we never know how high or how low prices of anything will go, except maybe to zero)
6)    When you don’t see the trend, don’t trade

It is so darn simple, yet so darn hard because our ego makes it so.

Does this mean we eschew all forms of fundamental analysis and just say, whoopee, the trend is my friend—stop reading the paper or reading research? Not necessarily.  (But if that better orients you to the trend, then so be it.)

It does say that all the stuff we read and think about MUST be validated by price before we act. Otherwise we get into the mindset the market is wrong and I am going to top pick right here. (I am guilty again as charged!)  

Doing your research homework should be about helping you position more quickly when you see a major conversion flow of consensus from one view to the other—trading with the new trend of the market early, but not trying to pick the exact turning points.  

We often hear of the famous contrarian who picked the exact top or bottom in a market, which helps on the fame and fortune front for a while. But this is survivorsip bias.  What we don’t hear about are all those contrarians who were carried out because their intellects picked too many tops or bottoms that never happened.  

For now, the trend of the stock market is up. The trend of the dollar is down. We capitulate as soon as we define the new trend. Stay tuned.  

Jack Crooks
Black Swan Capital 


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