RELYING ON HISTORY

Game designer Jane McGonigal once said, “I’ve learned an important trick: to develop foresight, you need to practice hindsight.”

When I read that line, I was so impressed with how relevant it is for market analysis. The market is throbbing with life today. When trading ends today, the entire throbbing action, changing from minute to minute or even second to second, all passes into history. And stays still for ever. All of us participate in the market today with our minds on tomorrow- how am I going to profit and how much, how am I going to avoid making losses etc. It is so very difficult for me to analyse the market as it unfolds because it is moving so much. I need a great deal of technology to analyse the current action to come up with something relevant, something that will tell me what to do, when to do.

Barring a few people (main Institutional), most others don’t have access to such technology (although that status is changing every year). So, how do people of that category- which is the large majority- then try to solve the issue? The only thing- even if second best – is to analyse the data that is non-moving. And, this means analysing history. So, clarifying what happened (hindsight) should now lead to what can happen (foresight).

Fundamental and technical analysis both rely on past data to create a scenario for the future. How accurate this scenario creation is done will depend on the extent of data as well as the skill of the analyst to put together the different variables in the data. With fundamentals, it becomes a detailed effort whereas with technicals, it is an easier job as the variables are limited to just two (price and volume).

The main reason why analysing the past data is not a difficult job- voluminous perhaps, but not difficult- is one reason only. The events don’t change any more. New events don’t occur any more. Hence the probabilities that are obtained by analysing past data can be more definitive. Our rational mindset shall demand that we have a positive expectancy from a proposed action before we can take that action. If we have set the probability for that, then it is not only easier to take the action but also to be confident about it.

The problems start when that action is taken into the real time, when markets are open and trading live. Now, new events are occurring continuously. Prices are never still, news-flow can come in from anywhere (TV, press, social media, reports etc. etc.) and with each passing minute or hour, there can be changes in the price. The probability that you set yesterday based on your analysis was on still data but it is now faced with some changing data- which also changes the probabilities.

Market success becomes, therefore, a function of the skill with which we can continuously change the probabilities. We increase positions when the probabilities are in our favour and decrease them when those probabilities drop. Humanly, this becomes more and more difficult as you go lower and lower in time frame. With technology advancing to where it has now, the field of Algo Trading has emerged to take care of such a need.  But again, algo trading is not everyone’s cup of tea- again being restricted to a few. It is solved, to a certain extent, by increasing the length of the time duration during which the new probabilities can be assessed and accounted for within one’s methodology.

The human brain is accustomed to think in patterns. It tries to store as many patterns as possible and tries to match a current pattern against a repository of stored patterns. How swiftly our brain is able to match a new event with an old pattern- whether in a convergent or divergent manner- depends on how much we have practiced that act. When neither of those two are possible, then our mind is left with a choice of either engaging in lateral thinking or even creative thinking. Here too, it is function of how we have practiced the art of thinking. Realise that we don’t do this consciously-it is an automatic process that culminates with an answer on which we act.

But again, we come back to the same point- that action with an eye on the future for a preferred outcome (putting on a trade) is really based upon the data from the past (i.e. History).

It is important to understand this aspect of human behaviour if one has to become a successful trader. Many new entrants to the market or the world of analysis, often question the relevance of historical data as a predictor of future price movements.

Schopenhauer – a philosopher of yore – realized this when he said, “The wise have always said the same things, and fools have always done just the opposite.” Reading books, analysing charts as many times as you can, practicing your method on as many examples as possible is the way to become the successful trader or investor that you have set out to become.