The Investor’s Journey to Profit

Over the last century, countless courageous investors have set out to discover the secrets of the market. While most investors are motivated purely by financial gain in the beginning, they often find themselves on an incredible journey of discovery.

There is no other way around it; stock investing is not a matter of gambling or dumb luck. To build a consistent wealth stream from stock investing requires strengthening the mind as well as building character.

Financial markets are a knowledge-rich field. Complex financial mathematics can give physicists a run for their money. At the same time, that complexity has not helped to reduce volatility. We continue to see repeating systemic meltdowns globally.

We have all heard stories about legendary investors. When we read their books, we often get a sense of overwhelming confidence; as if we are given the green light to do what they have done. It is not until we start to make meaningful losses that we question our methods.

From there, the journey begins.

Soon enough, we ask ourselves a fundamental question – is there really a consistent way to make money from stock investing? If yes, we would like to know how. If no, we would like to know why.

The cornerstone theory in finance should be hard to miss — the efficient market hypothesis. It describes the market as random and unpredictable. It states that winning in the stock market must be a result of luck and cannot be repeated systematically.

Now, that creates a problem for investors who read up on this theory. Does that mean we are just wasting our time playing the market? The fact that nobody has been able to disapprove this theory is all the more discouraging.

And this is when the contradictions start to fall into place.

The counterargument to the efficient market hypothesis is that there are clearly successful investors, funds and banks that are systematically making money from the market. And the academics themselves contradict each other as well all the time.

In the face of growing contradictions, we learn to trust our instincts more than other people. We say to ourselves, ‘I believe there is a way, I just don’t know it yet’.

Many begin to contemplate the possibility of a seemingly random market, but with an overarching trend or system to govern it. This would undoubtedly give us clues on the ‘magical formula’ for making consistent gains in the market.

That leads us to Chaos Theory.

The rise of trend investing in a chaotic world

Chaos Theory, a mathematical system between complete determinism and unpredictable randomness, studies phenomena that are random in the short term but are absolutely determinable over the long term.

That has to be it…the perfect explanation for why short term stock prices are unpredictable, but are profitable for successful investors over the long term. In effect, successful investors must have understood the nature of the chaos.

Fractal geometry is the close cousin of chaos theory. It describes the concept of a large shape containing an infinite number of similar shapes under magnification. For example, a triangle that can be made of an infinite number of smaller triangles inside it.

An investor can quickly see the link between fractal geometry and technical analysis or charting. Chartists use geometric shapes to determine their trading strategies. And if you think about it hard enough, the medium term and long term stock charts do possess similar shapes as the short term and ultra-short term stock charts. That seems to indicate chaos in the system.

Without going too deeply into Chaos Theory, just the fact that stocks possess trend behaviour is enough to put investors’ minds at ease. It confirms that there is at least some form of possible systematic approach to stock investing.

Scanning through hedge fund performances can give you plenty clues about what works and what doesn’t. See this latest CBNC news from last week:

The strategy that has been winning the year so far is dictated by computers: systematic hedge funds that surf trends using financial models and algorithms have dominated the lists of the best-performing funds.

It gives us at least two clues. One, there are strategies that tend to work overtime. Two, one of those strategies is trend investing.

As the analyst for Emerging Trends Trader, I can tell you that this piece of news is accurate. Trend investing is a particularly straightforward strategy to learn. However, trend investing is not as simple as just following a trend. That’s likely to see you lose money over time.

At the end of the day, what matters most is still profitability. But in order to get there, investors may very well enjoy the intellectual pursuit that is the essence of their journeys.

Cheers,

Ken Wangdong,

Analyst, Emerging Trends Trader

From the Port Phillip Publishing Library

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