Tuesday, January 20, 2009

The Trend is Your Friend (and most likely a demi-god, so be nice)

Odds of 58.2% with equal downside and upside is a bet you would want to take, especially if you could take it again and again. Although the edge may look insubstantial, no casino you go to or lotto you participate in is going to give you such an edge. If you're relatively patient, I'm certain you'll be somewhat pleased over time (unless you were looking for a rush).

The screenshot clip is from a new game at Wall St Survivor that allows you to bet 50 "loyalty points" on the next tick on a random stock. What I did for 122 times (I had to get to class, but I did this last week too, with similar positive results) was place my bet on whatever direction the stock was heading at the time. Basically, I was following an extremely short range trend. If the line chart was heading up, I bet up; and, vice versa. Not bad for little effort (albeit, you need 50,000 loyalty points to trade for $5...if only I could develop a cmoputer program to do it for me).

You may be thinking: hey this is cool, but I don't think it will work on a larger scale. Well, I beg to disagree, and so do many influential and successful economists, traders, and investors. Here is my theory--derived and distilled from such brilliant minds as Robert J. Shiller, Charles Kirkpatrick, and Michael Covel, among many, many others:

Trend following works on the large scale because when companies are successful (or percieved to be successful) people will continue to invest in them, pushing stock prices up. Most people are not going to put their entire savings into a stock and never invest in it again. Many people are going to put some money into a stock, wait for their next paycheck and put more money into it as long as the stock continues in a positive direction. They may also tell others about their success, increasing the demand for the shares, further strengthening price. This is what Shiller refers to as a postive feedback loop. As money experiences success, more dollars will follow.

The same works for the downtrend. If people are panicking around you, you (maybe not you but the statistically average person) are also going to panick. The process feeds on itself driving prices further downwards. People will probably tell their friends about their lack of success in the stock market and warn them to stay away. People may also feel sick to their stomach continuing the optimistic investment process they had performed up until then, further reducing demand.

So, why does this work in the short term? Well, in order for the line chart to be driven upwards, greater demand than supply must be present, meaning more buyers than sellers (i.e. a greater chance for an uptick). When there is a greater supply than demand, you will have the opposite.

Put your bet where you have the greatest odds.


Anonymous said...

could not access www.wallstsurvivor.com

Complacent Panda said...

Sorry. Meant to link it.

It is www.wallstreetsurvivor.com