Highest Probability Trading

There are no dead certs in the markets, only probabilities. No discipline or indicator works all the time, but some things work most of the time. Draw those together, and I believe we get somewhere towards highest probability trading. I am sure different successful traders would have varying views on what would make up trades of highest probability, but this is how I see it:

Equities are the best performing asset class over time by far, see here:

22mar2013

So, broadly speaking, long equities is the trade. This is backed up by stats showing that stocks are in a bull market 80% of the time. Bull cycles in stocks have an average duration of 5.4 years and an average gain of 74%. Bear cycles average a duration of 1.5 years with an average loss of -12.7%. If we also include the fact that secular stocks bulls go upwards whilst secular stocks bears go sideways – rather than down – then a naturally bearish bias is an impediment in playing the markets.

I also suggest the trade is to be long a stock index rather than an individual stock. Roughly speaking, 50% of a stock’s movement is attributable to the overall stock index, 30% to its sector, and just 20% its own. Individual stocks can go bust, or plummet on surprise bad news.

I believe that the shorter the trading timescale, the more randomness and noise there is. Many people (and machines) buy and sell specific assets at many different times for many different reasons. The longer the trading timescale, the clearer the trends. However, trades left on for years will be profit-diluted by counter cycles within an overall trend. So, if we can identify when cyclical stocks bulls begin and end, we could go long the stock index for the duration, or we might look just to capture the significant upwards swings within that.

How can we identify the beginnings and ends of cyclical stocks bulls? Well, there are no hard and fast rules and it is not easy, but history, as always, is our guide. Cyclical stocks bulls normally end with yields rising, inflation rising, and tightening that chokes off growth. They end with a topping process, a price range lasting several months, with divergences in breadth and leading indicators. They end with overly-bullish sentiment and valuations. In contrast, cyclical stocks bulls begin with overly-bearish sentiment, a capitulation in breadth, positive divergence in leading indicators, and often a V-bounce price bottom. We can also draw on solar-secular history to gauge likely timings of starts and ends.

Within cyclical stocks bull markets, there are ‘swings’ which I suggest are largely sentiment-driven by levels of geomagnetism. The SP500 v. geomagnetism for the cyclical bull of last 4 years is shown below:

13mar20131

So, we might refine the highest probability trade and suggest the trade is long the stock index during cyclical stocks bulls whilst the cumulative geomagnetic trend is upward. We can identify a likely change in geomagnetic trend using the 3 week geomagnetism forecast and the typical seasonality of geomagnetism, both of which I model.

Within that, there is lunar phase oscillation. The period into and around full moons is largely one of poorer returns than the period into and around new moons. So, we might go long the stock index at the start of each positive lunar period and close at the end of the positive lunar period, during cyclical stocks bulls whilst the cumulative geomagnetic trend is upward. These trades would last around 2 weeks each.

So which stock index might we use? Dichev and Janes showed that all the major stock indices around the world show better returns around new moons than full moons, but two of those showing the biggest differentials were the German Dax and the Singapore Straits Times. Whether this is something cultural that produces greater sensitivity to lunar phasing, or whether this is because more traders use moon-phasing in these countries, would perhaps be another paper in itself. But the German Dax and Singapore Straits might offer the best returns if we are to trade the positive lunar fortnights only.

22mar20134

22mar20132

Source: Dichev/Janes

What about geomagnetism sensitivity? Krivelyova and Robotti revealed that most major country stock indices perform worse following geomagnetic disturbances. However, Germany and South Africa were the exceptions. My cumulative geomagnetism chart above calls into question their assessment of Dax non-sensitivity (I suggest this is because of method – they only looked at performance up to 6 days following a geomagnetic storm rather than using a cumulative trend in geomagnetism). Nonetheless, by their research, the stock indices with the biggest differentials for geomagnetism were the US indices.

I suggest, then, that we might trade the German Dax, the Singapore Straits Times and the US SP500, and this has the benefit of diversification, with stakes in America, Europe and Asia.

Lastly, rather than mechanically trading this idea, I would like to look at each such opportunity and assess whether the stock indices are overbought or overbullish, and how they stand technically (at support or resistance or in bullish or bearish patterns). I would be keener to take the trade if stock indices are not overly frothy, not bumping up against key resistance or carving out potentially bearish formations.

So let me sum up. My suggestion for trading of the highest probability is to go long (i.e. buy) the German Dax, the Singapore Straits and the US SP500 (for diversification and natural sensitivity) at the start of each positive lunar period and close (sell) both at the end of the positive lunar period (roughly a fortnight), during geomagnetic uptrends within cyclical stocks bull markets, repeating these trades each lunar month where the stock indices are not overly bullish or overbought or suffering bearish technicals.

What’s your take on this, and what would you consider trades of highest probability?

In the next post I will delve deeper into this idea, and offer supporting statistical evidence.

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6 thoughts on “Highest Probability Trading

  1. Very interesting post. Thanks. If I’ve understood correctly, would entry / exit positions be specifically on the new moon / full moon dates? Or +/- a few days?

  2. This is fascinating stuff! I love it because I have been testing the lunar cycle myself, but now realize I may have had it all wrong. I was trying to buy the full moon and sell the new moon.

    My thoughts were that the new moon would be the height of optimisim, so the markets would be more likely to sell of, and the full moon would be the height of pessimisum, so more likely to be oversold.

    I was testing it based on that lunar cycle, but using a momentum indicator to determine if I should buy or hold.

    Now I am having to go back and re-evaluate.

    Thank you for sharing these last two postings.

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