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work。of Harry M。 Markowitz； 1990 Nobel Prize winner。 He wrote a series of papers。in which he demonstrated that the major part of all share price moves。was。due to these macro factors。rather than stock…specific。information。 This。is。analogous。to knowing that the tide ising in and will float all boats； or it is。going out and will leave them all back。on the beach。 This。is。more important than knowing that this。boat is。better than that boat。 About 85 percent of the movement was。due to the tide。
I am not alone in respecting the powerful influence of market trends。 Years。ago； however； most market participants。believed in the Efficient Market Hypothesis； which gave rise to the more well…known Random Walk。Theory。 This。theory asserts。that market movements。are random。 Therefore there is。no point in trying to prehend market trends。 Predictably enough； those who asserted the contrary view—technical analysts； also called chartists—were considered fringe players。
Nowadays； however； it has。bee more than respectable to dismiss。the Random Walk。Theory。 Several Nobel prizes。have been awarded to those who did just that。 I offer less。esoteric。proof。
First； humans。are irrational and exuberant； and have regularly overpaid for everything from tulip bulbs。to dot… stocks； and many things in between。 Second； there are in practice real…world markets。that are easily and demonstrably different from the markets。that would be created were the organizing principle a random walk。
Professor Benoit Mandelbrot has。a great way of demonstrating this。 By plotting the deviations。of actual prices。around a moving mean and paring them to a random walk。generated by hisputer； he can reduce the problem to a party game。 A child with the mental age of four； and no previous。training； can easily tell the difference。 In essence； if the markets。were really random； then the deviations。would be in Normal； or Gaussian； distribution。 In fact they are in skewed； heteroscedastic； leptokurtic。distribution。 This。is。the so…called fat…tailed pattern shown in Figure 10。1。
In a leptokurtic。distribution； prices。spend far longer than they should close to the mean。 They remain mean…reverting and range…bound。 Then； when they
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It moves。ahead of the real world。 It sometimes。makes mistakes； leading to the old quip that the market correctly identified all nine of the last lour recessions。
Schumpeter's。model included three cycles。of different lengths： a very long one that he named after Kondratieff； a ten…year one named after Juglar； and a four…year one named Kitchin。
I use these in the following way。 The long； Kondratieff waves。I call secular trends； as。they persist for longer than the short cycle。 In practice they tend to run for multiples。of the four…year wave； with sixteen to twenty being mon lengths。of time to be valid。 All we need to know at any particular time is； are they going up or down？ The sent of force that drives。these trends。can be technological innovation； a rapid rate of pound growth of GNP for a country； earnings。growth for a stock； demographics； and expansion or contraction of valuation。 All those forces。themselves。trend。
When Great Britain was。a superpower； the Kitchin wave averaged 4。23 years； but it had considerable variation。 An individual cycle could be as short as three years。or as long as。five。 Since Roosevelt； however； the United States。has。been the superpower； and the cycle has。bee phase…locked to the presidential election cycle； which is。mandated at exactly four years。 It is。the lows。of the cycle that can be locked down accurately。 The analogy is。with a child's。jump rope。 He holds the ends。of the rope in his。hands； but the top of the loop moves。around rapidly。 In all that time there has。been only one time so far when the lows。of the cycle were not exactly when they should be。 The four…year low should have e in 1986； but the market did not fall until it crashed in late 1987。 The next time that the cycle mistimed was。in 2006； as。the rhythm indicated a market low； not a high in that year （see Figure 10。2）。
During the course of a normal four…year period there will tend always。to be a rotation of the strongest trends。from bonds； to equities； to modities； always。in that order。 Within the equity market there will also be a rotation of sectors。starting with interest rate…sensitive issues； to consumption…related； to cyclical laggards。and resource…related issues。 This。has been well…illustrated by the work。of Martin Pring； Ian Notley； and John Murphy。 Following my。system for these rotations。will lead to moderately active investment； but not hypoactive。 Typically I have found that for a large market like the United States。or the U。K。 the average holding period for a stock。might be as。long as。nine months。 There can also be times。when it is。nearer to three months。 Total turnover is。high pared with a normal private portfolio； but low pared with a hedge fund。
Figure 10。3 shows。that a secular downtrend was。in place from 1966 to 1982； an era for active management。 From 1982 to 2000 a secular uptrend took。place； when a more passive style worked well。 Since 2000； however； active management has。been required again。
Notice in Figure 10。4 that； since 1968； when the S&P 500 index is。plotted against gold bars。it has。performed badly。 What this。really emphasizes。is。the
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Because it is a democracy rather than a munist state； India will likely be the more rewarding stock。market。 Certainly any investors。who ten years。ago correctly identified the growth the Chinese economy was。going to have and duly bought a China fund would by。now have lost about 70 percent of their money。 India； conversely； has。done extremely well； as。Figure 10。6 shows。
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tive trends。 Buys。are selected from the top of the list and sells。from the bottom。 There will be a bunch in the middle that are neutral。 I do not exert myself in trying to find the very。best market or stock。 That is。obviously a difficult task。 Instead I do the easy thing and identify the average or below average。 And I don't own it。 I define a good stork。as。one whose share price goes。up while I do own it。 The winners。select themselves。by going up and staying in the top part of the ranking list。 Simple though this。system is； it works。very。well。 I have not found a universe of markets。or stocks。on which it does。not work； even though the volatility of different universes。varies widely。
Trading Rules
We now need to devise trading rules。to get us。in and out of our selected positions。 I have not invented any new indicators。 I did not invent the wheel either。 It seemed to be there when I needed it and I use the ones。on my car because they work。well。 It is。the same with indicators。 We learn through back…testing that many indicators。work。well some of the time。 A few work。well a lot of the time。 None work。well all of the time。
In a leptokurtic。distribution prices。will spend about a third of the time in a narrow range； and about a third of the time each in an uptrend and a downtrend。 Each situation requires。three sets。of indicators。 What my method values。most highly is。not a range trade but a strong absolute and relative trend。 We use the indicators。（like RSI； MACD； OBV； Bollinger bands； and others） that are set up as。standard defaults。on the Bloomberg Professional…service。 They are more than adequate for our needs。 There is。of course a built…in bark…test facility。
Once the appropriate indicators。have put us。into the positions； we simply hold on until one of the prices。drops。enough to hit a stop…loss。level。 We then sell out and buy the next stock。or market that has。now been promoted up our ranking table。 We always。remain invested until the index itself gives。a sell signal； by hitting its。own stop…loss。
This。level is。a trailing percent behind the rising price。 We do not use a fixed percentage trail but one that varies。with the market or stock。and is。proportional to the volatility that is。normal for that item。 I call this。the volatility。signature； or sometimes I call it beta with bells。on。 For example； the number for the FTSE index is。7 percent （see Figure 10。9）。 In a bull market this。index almost never has。a setback。bigger than 7 percent。 Trailing up this。much below the rising market index will keep you in a bull till virtually the end。 However； a stock。like BP is。inherently more volatile； and the signature works。out at 13 percent。 The price regularly swings。that amount while still in an uptrend。 The signature for an index like the BSE Sensex （India） is。18 percent。
It is。delusional to think that we can get away with very tight stop…losses。and never lose money。 As。Figure 10。10 shows； if the stop is。too tight； you will overtrade and make nothing。 If you do not risk。anything； you will not make anything。 We can see that； over time； the more volatility we can accept； the more money we will make； within reason。
Of course； we do have to survive in the game。 Figure 10。11 shows。how much we need to make to win back what might be lost on a very volatile swing。 If we lose； say； 5 percent； we need to make just over 5 percent to get back。onside。 If we lose 10 percent； we need to make only 11 percent to be all square。 If we go down