Guessing Is NOT a Good Thing for Traders and Investors. Do This Instead. By, D. R. Barton, Jr.

Through the years (okay, decades) I had the joy and pleasure of teaching many classes with Van. Even though he was a mentor to me early in my transition from chemical engineering to the financial markets, he and I always had the type of relationship where conversations could range from deep intellectual or spiritual discussions all the way to crazy fun diatribes about pop culture. We also LOVED to play his trading simulation games, sometimes jumping in with students. There was one trading simulation game that I loved to play and still do. More on that specific game below (and how you can play it, too).

But first, let’s look at a data table I saw, from LPL Financial, that made me think about this whole article because it made me think differently about the current market conditions. Unless you’ve been under a rock, you know that the U.S. stock market is off to one of its worst starts of the last century:

You’ve probably heard that last Friday (May 6th) marked a rare sixth straight down week in the markets. It’s a rare occurrence to have so many consecutive down weeks because we have been in an expansionary economy. The excellent blog, A Wealth of Common Sense answers the question, “Why does the stock market go up over the long-term?” like this: The economy grows and corporations earn more money. In 1928, earnings per share for the S&P 500 was $1.11 while corporations paid out $0.78 per share in dividends. By 2021, it was $197.87 and $60.40, respectively.

Here’s the reason for today’s title about guessing: Given that long-term bullish data, my mind took in the thought of six straight down weeks and immediately guessed that an unusual streak of consecutive down weeks should lead to some upside relief. But I certainly couldn’t act on that. I’d like to have a more systematic approach to making a trading or investing decision, even if that decision is to “get ready” to put some new money to work. I found this data almost immediately:

In short, long stretches of down weeks don’t lead to snapback rallies. Instead, they lead to “coin flips” over the next three and six month periods—no discernable edge. Here are two things we can take from this data:

  • Twelve months after the long streak of down weeks, the market does have a good record of recovery.
  • But more importantly for today, a quick glance at this data shows a large amount of variability.

This means that the crazy day-to-day volatility that we are seeing today is likely to last for a while.

So yes, my “guess” that the series of consecutive weeks of down action should lead to a move up in the short or mid-term, proved to have no edge.

I think that’s the most important point of this exercise. Hunches and guesses should give way to a systematic approach to analysis. (It sure kept me from jumping to conclusions here!)

My Favorite Trading Simulation

The trading simulation I mentioned above that Van and I played together many times, is another analysis tool that changed the way I look at market approaches and especially at creative position sizing.

I just got a text from RJ Hixson and he told me that he plans to run my most favorite trading simulation in the upcoming How to Develop Winning Trading Systems That Fit You Workshop. This simulation made me change my mind about the power and efficacy of “layering” or scaling into positions. I have played this particular simulation with many professional traders and with novices and it never fails to give me (and everyone who jumps in) multiple lessons in money management. I’ve taken part in many truly epic battles with friends and even a few other instructors that you know well!

As always, please send me your thoughts and comments. I always love to hear them and I answer as many as I can! Email them to drbarton “at” vantharp.com

Great Trading and God bless you,

D. R.

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Brian G.

Thank you for this information!

I recently read your book TMM, extremely helpful!

Is there a link to the simulation game you refer to?

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