A cursory glance at the sea would not pick up much, except that it never sleeps, and is constantly changing. There is a lot in common between the sea and the market, says James Paynter in Part 1 of a three-part series in an effort to educate our readers on how to read the markets.
Respect the tide, ride the wave, watch the ripples...
We have heard some of these expressions before and no doubt to some degree have experienced them ourselves in a positive and negative way - perhaps the joy of simply being carried by the tide, or the helplessness of fighting the tide.
And what about the exhilaration of triumphantly riding a wave into shore, or the desperation and panic of being unceremoniously dumped by one (the proverbial 'wipeout')?
These are valuable lessons to learn in respecting the sea but these can also be just as valuable lessons to learn in respecting and surviving financial markets (whether currencies, stocks, bonds or cryptos), and understanding the forces that move them and their ever-restless nature.
The fact is, there is a lot in common between the sea and the market.
A cursory glance at the sea would not pick up much, except that it never sleeps, and is constantly changing.
And so it is with the markets as well – the more we observe them, the more we see patterns and cycles to these seemingly random fluctuations, and various degrees of trends (actions and reactions) superimposed on each other.
This is what we hope to cover in the next post or two, with this one being centred around the tide in markets.
Of primary importance is the major trend, in any market (one spanning several years), which can be represented by the tides of the ocean – the underlying trend caused by the major pulling forces of the sun and moon.
Remember how, as a kid, you built that beautiful sand castle well away from the sea edge? Only to see the waves steadily getting closer and closer? And no matter how much you try and protect your castle, eventually the waves flatten it and you need to start all over again - further up the beach?
Yes, the tide – this primary force and cycle of the ocean – caught us out many times as kids. And it still catches us out time and time again (when last did you get your towel soaked by the advancing sea?!)
Because we tend to look at where the sea is now, and make our plans around the fact that the status quo will remain – instead of finding out:
- The current trend (rising or falling tide); and
- The historical limits of these trend cycles (low and high-water marks)...
...And then using this information to make informed and intelligent decisions. And we make exactly the same mistake with the markets.
How often we make decisions based on where the market is right now, without any concern as to what the trend is, or what stage it is in (early or mature)?
Or worse still, we extrapolate the current market trend indefinitely into the future (which is as crazy as expecting an ever-rising tide), instead of understanding the direction of the current trend, and how far the market is expected to go before reversing – based on historical trends.
And the result is disaster!
The recent decision by the Central Bank of Iran to peg the value of the Iranian rial after it had lost 20% of its value is a case in point – and one that is unlikely to be successful.
They need look no further than the Swiss National Bank (SNB) for an example of how this will turn out. The SNB decided back in 2011 to build a sand castle to protect the Swiss franc from dropping below 1.20 francs to the euro.
The tide (primary trend) was against them, but they thought their sand castle would hold up.
Which it did – for a while, until 15 January 2015 at 11:30 (South African time) to be precise.
And then - bam! It was game over!
Just like our sandcastles as kids, it only held for a while until the enforcement gave in, and the sandcastle was swamped by the underlying tide.
Eventually the tide won – as it always was going to.
This should be a lesson not only for all central bankers, but for all those exposed to currency swings, whether importers, exporters, investors or traders - Don't ever fight the tide! You will lose!
It was a lesson I learned myself back in 2004! And an expensive one too.
We earned foreign currency in our investment management business, and from 1993 to 2001 we had seen the rand steadily – and then rapidly – depreciate from R3.00 to R13.85 to the US dollar, which was great for an export-based business.
And we merely expected this trend to continue, but then the tide suddenly changed and it trended the other way for four full years - strengthening all the way back to R5.60 to the dollar by early 2005.
And what did we do?
We fought it all along the way, because it did not suit us (...sound familiar, Mr SNB chairperson?).
A very costly a lesson learned in the school of hard knocks.
The fact is, we could have avoided this if we had the right information and had recognised that the rand had reversed its 30-year upward trend in 2001.
And I want to ensure that you learn our lesson - without the hard knocks part.
There is a lot more to surviving the sea than just the tide, and there is a lot more to surviving the markets than just the primary trend, but one lesson at a time, starting with the first and most important one - respect the tide, and understand where it is headed so you can use it to your advantage.
While it might be easy to figure out what is happening with the tide, and when it is about to turn, doing so with the rand and other markets is not as easy.
What is key here is to have an objective, scientific-based view of these inter-related market cycles that enables you to make educated, informed and rational decisions, instead of emotionally-charged irrational ones (which we will default to every time).
Watch out for our next articles on the Waves and Ripples in the next week or two.
* James Paynter is a financial market analyst and founder of Dynamic Outcomes.
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