I often get ideas for Blogs from various chats on Twitter and this one has come about in this way, and it also has the added bonus of being sort of linked to the recent lengthy Blog Series I wrote on ‘Wheelie’s New Improved Index Trading System’.
We were having a debate about what drives Indexes in terms of Price Rises and Falls etc. (I think it was with @Old_Man_Trading who is really hot on the TA stuff and well worth following on the Tweetster) and I put forth the idea that to a large extent we cannot know what is driving them as there are simply too many factors involved. To illustrate this, let me start off by listing things that might be drivers, and note they can probably be broken down into a few Headings:
Political / Policy Issues:
Investor driven issues:
I have spent a few minutes on this List but not too long. It is not meant to be 100% complete (I am not sure such a List would actually be doable - there are just so many possibilities for what could drive Price Moves) - the Key Point I am trying to get across is that at any given time, there are so many Reasons/Motives in a Market to explain the Moves that we simply cannot ever know what is really driving the Index Prices - we might be able to guess at a Dominant Factor on a particular Day/Time but in general we can never know.
When a Dominant Factor is the Driver
Having said that, I think there are occasions when there is a clear Dominant Factor that is pushing the Price around - but thankfully these are rare because they tend to be a Negative for Stocks although occasionally they do cause a Strong Move Up. These kind of things are Events like the following:
In these cases where a Dominant Factor is negative it tends to become all-pervasive and it is all we get on the News and it is no wonder that People get dead scared and it makes them Sell their Stocks - and of course such Selling begets more Selling as Investors get more and more panicky and of course the Sharpest Traders (who have probably been Stopped Out when they were Long !!) have learnt to go Short and this helps fuel the Rout. You can almost guarantee that when the Mainstream BBC / ITV / Sky News are all talking about Stockmarket Falls as the main Headline that the Markets are about to Rally hard.
Thinking about it, in many ways, when such a Dominant Factor is clearly driving things it is probably a lot easier to Trade a Market on the Short (or very rarely the Long) side of things. If you think about it, events like a Presidential Election are well known in advance and the Date is know to everyone so you can plan in advance what stance you are going to take in the lead-up to the Vote - and in most cases Markets will probably drift down before and then Rally hard on the Result.
On an Intraday basis certain bits of Economic News (for example some PMI Purchasing Managers Index Numbers or of course the infamous US Non-Farm Payrolls on a Friday) can clearly be seen to drive the Markets - but this is only a very short lived thing and very quickly any variation from Expectations is baked into the Market prices. The Market is extremely efficient at discounting such Information very fast. As a Long Term Investor I am really not too fussed about this.
Liquidity is the Key
The common element among Indexes and Megacaps and Large Stocks (perhaps the FTSE250 is less prone to these effects and Smaller Stocks are definitely less impacted) is the Degree of Liquidity. When an Asset is highly Liquid it is dead easy to Buy and Sell that Asset at any time and there are always Buyers if you want to Sell and Sellers if you want to Buy and the Price will be pretty much what you are after. This Liquidity makes Big Stocks very good Investments for people who do not like swings in their Holdings as it means they are far less Volatile.
However, this Liquidity is in part a ‘problem’. If you were to buy a Megacap Stock because it pays a Decent Dividend and has a solid Long Term History as a Company etc., then that is all well and good. However, I suspect that if you are Buying a Megacap or FTSE100 Stock because you think you know something other People don’t, then maybe you are highly over estimating your abilities to Pick Stocks compared to other Market Participants. When you are Buying a Megacap Stock you are in effect making a commitment that you know more than an enormous Number of other People - is that really likely, however good an Investor you are?
We are up against a ‘Wisdom of Crowds’ thing here where the Theory goes that Individual Investors can be Right or Wrong about a Stock but over Thousands and Millions of them the chances are that the Majority will get it Right - of course that is very difficult to be sure of and depends on Timeframe as well. The Majority might be wrong over 3 months but on a 2 Year view they might be proven to have been right to Buy in.
However, when we start to talk about less Liquid, Smaller Stocks, then it might be possible to ‘Have an Edge’ because you are up against a far smaller Number of other Investors and Traders. For example, on a FTSE100 Stock you are not only ‘competing’ with other Investors who are similar to you but also you are up against many Professionals who have the backing of Research Departments and Junior Fund Managers and Analysts and stuff which should in theory give them considerable advantages. When we move onto Smaller Stocks though, there are far less People involved in ‘playing’ them both in terms of Private Investors like what you might be and also in terms of ‘Professionals’ because the low Levels of Liquidity mean that Pension Funds and Unit Trust Companies and stuff totally avoid this end of the Market - so already the Odds are better for you as a Stock Picker.
I am a big fan of IPOs (Initial Public Offerings - a Flotation when a New Stock appears on the Stockmarket) and one of the things I really like are the Small Companies that arrive on the Markets because I think they are often ‘Under the Radar’ and the competing Private Investors are far lower in number and the ones that there are might be less informed than I am if I work pretty hard. A great recent example of this is Diversified Gas & Oil Corporation DGOC where most people seem to have failed to understand exactly how the Company is able to obtain very Cash Generative and dependable Assets as Oil Majors offload the Conventional Oil & Gas elements of a Shale Licence which is really what they are after. If seems to take many many months before the Market wakes up to a really good IPO story when it sits in the Smallcap arena - I doubt this is the case with FTSE100 IPOs where everybody is expecting it and it has been Analysed to death by various participants in the Financial Services Industry from Investment operations to the Financial Media.
OK, I see your point Mr Wheelie, but what are you suggesting we can do about it?
Well, don’t just take my word for it. Warren Buffett (whoever he is) has a prepared Quote for this subject as always, this time it is:
“I spend an Hour a Year on Macroeconomics………and it is an Hour wasted.”
And for Belt & Braces, on Saturday 21st April 2018 I was at the UK Investor Show in Westminster and the Legendary Mark Slater (certainly one of the best Fund Managers in the UK) during his speech repeated what he always says that there are always Macroeconomic Worries around and we should just ignore them and concentrate on researching Quality Stocks and rather than timing the Market as a whole, we should be more focused on taking advantage of Opportunities that the Market gives us from time to time to pick up High Quality Stocks that we want (we might even own them already and we are buying more) at temporarily depressed Prices.
Clearly I have to agree with what these guys are saying and I would be a bit of a Fool to go against the wisdom of such outstanding Investors. In addition, I would contend that there is another simple reason why it is a pretty fruitless exercise trying to understand what is driving Markets in the main - the simple truth I find is that ‘Price tends to move before the News’ - in other words the Market has already moved by the time something has occurred - the Markets discount events in advance. This lines up with the famous adages:
“It’s better to Travel than to Arrive” and “Buy on Rumour, Sell on Fact”.
So the essence of what I am saying is that all this Macro Babble is just ‘Noise’ and the best thing we can do is to ignore it and stop worrying about it - all we need to know are headline items like the following:
This is not an exhaustive list but should give you an idea of the sort of stuff that is worth knowing - but this is all pretty simple and basic stuff and if you read Investors Chronicle every week then Chris Dillow always covers these sorts of things. Don’t over think it and make it too hard - there is no point.
Anyway, you might as well forget everything I have written so far because the SOLUTION is as follows………….
Drum Roll please…….
Charting !!! (Trumpets, Fireworks, Party Poppers, Dancing Girls, The Chippendales, etc. etc.)
Yes, that is it. Good old humble Charting. OK, if you are snobby and all intellectual then let’s call it ‘Technical Analysis’ if that makes you happier. But it really is that simple.
Except for truly one-off Shock Events (like the Terrorist Attacks on the Twin Towers in 2001), EVERYTHING IS ALREADY IN THE PRICE - the Price moves before the News. So what is the point in obsessing about all this Macro Babble - forget it, all is NOISE (unless of course you are a Day Trader in which case you better get obsessed by the Marco Nonsense !!).
And the added beauty of Charting is that it also encapsulates the Sentiment of all Market Participants - this is something that is entirely unknowable - but you don’t need to know it. This is a huge help - for example, if you have a Big Quality FTSE100 Stock which has been in a Downtrend Channel for 2 Years it is very simple to spot when the Price is starting to escape the Downtrend Channel - once this happens you can take heart that the Sentiment towards the Stock and its Perception by other Market Participants is starting to improve and this also tells you something about the underlying Business and how things are most likely getting better. When they Break the Downtrend Channel it is often a good time to start Buying a Stake - you can add more once it starts getting some decent Upwards Momentum (this is also much less Risky than buying when it is still a ‘Falling Knife’).
There you are, forget it all, just crack on with learning how to use Charts effectively and Cut out the Noise.
Oh, and here’s a KISS from me…..
‘Keep it Simple, Stupid’.
I was talking in this one about ‘Having an Edge’ so this seemed relevant:
This one I wrote years ago but I still think it is really important and the stuff discussed in here is widely misunderstood:
And in case you haven’t seen the recent Blogs on the ‘Index Trading System’ here they are - there are Links to the earlier Parts at the bottom of this one:
And a very old Blog on the subject of Noise:
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