Nov

20

Many assume the continuation of trends beyond their turning points. Such thinking is evident in the news. The opposite view is the statistical lack of trends and the assumption of reversion to the mean. However trends exist in a random or due to macro effect such as government (mis)policy or herding, none of which can be ignored except to one's detriment. The pure quantification of price makes discernment of the change of cycles hard to see except in retrospect, thus other forward and current input seem worthy to consider. There are tells to macro effects if they can be discerned. The random trends also may have their characteristics. Philosophers like to define their terms, and traders also need to define their time frames to clearly state the issues. This seems to be a common point of misunderstanding in debates on these issues.

Steve Ellison writes:

As long as governments feel the need to intervene whenever their economies are considered bad, there will be business cycles that result in multi-year trends in earnings and prices.

In a much shorter time frame, order flows can cause intraday trends. If a mutual fund has a quota to buy a certain number of shares before the close, the fund's buying may push the price up. When there was floor trading in cotton, the locals loved to push prices to levels where stop orders were clustered. Every once in a while, the price would rise or fall by several percentage points within minutes as waves of stop orders were triggered.

In academic theory and simulations, trends occur when markets are mispriced, as informed traders use market orders to buy undervalued assets or sell overvalued assets (see, this chart, for example).

Finally, as Mr. Sogi notes, some trends may be random. Professor Aronson suggests flipping a coin 300 times and charting the cumulative difference of heads and tails to get an idea of what a random walk can look like. My first attempt resulted in the attached chart, which appears to have clear trends even though the underlying process was random. 


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  1. Craig Bowles on November 22, 2010 8:33 am

    We often think of things as being random and then come to find out we just lacked the knowledge. It seems like the whole solar system is interconnected in ways we never could have imagined. What’s going to be interesting now is the metals. The last couple of reports have shown the economic lagging index has positive growth rates. That’s normally the part of the cycle to get excited about metals. Loose monetary policy would move to neutral if on a gold standard but the Fed doesn’t do this, so give opportunity. Inflation indicators are starting to pick back up but still negative growth rates, so maybe we get another dollar rally around year-end like the last two years and see what happens after. The Fed not firming up policy at this point is how we’ve previously ended up with inverted economic indexes. Then you either have bonds or short stocks depending on inflation indicators. A gold standard would never get to such a point.

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