Stock Market Rhythms

Ned Goodman, long-time professional investor in Canada, likes to say that history may not repeat itself, but it often rhymes. There are many views that, while history may not predict the future, we can learn from history. There is also a sense that, when investing, timing is important. Here are various perspectives on the rhythm of market movements.

Wave theory exists on a number of scales. The Elliot Wave Theory, for example, suggests that patterns exist in scales of decades, years, months, days, hours and minutes. Further, it suggests a regular up-down-up pattern.

Technical cycles suggest that the market changes direction or changes rhythm on predictable timeframes. These might be cycles of 21 days and 105 days, or it might be cycles (based on moving averages) of 50 days and 200 days. Looking at these timeframes will help a market watcher to predict how long the current trend will last, and whether the trend is likely to reverse itself.

On the one hand, these cycles may have a base in human psychology. People tend to change their mood based on their circumstances, their environment and the moods of others around them. This is demonstrated in seasonality and herding in the market. On the other hand, our human brains are basically sensitive pattern-detectors. Because we are so determined to find patterns (which easily compress, to save memory and decoding effort), it becomes easy to see patterns even in randomness. It is very difficult to know whether cycles exist, possibly due to human behaviour, or whether we are finding patterns in noise.

Another example of the rhythm of markets is trading time. I first heard this term used when reading the work of Benoit Mandelbrot. According to Mandelbrot and consistent with my experience, time isn’t experienced as a uniformly advancing phenomenon by stock traders. Certain events cause time to speed up or, rather, for more actions (trades) per minute to be effected. These may include a news item, a corporate action, such as a merger, the publication of a revised forecast or a financial document. It might also be in response to other actions in the market, such as a sudden large buy or sell order or a change in price of the shares of a competitor. Traders will review this information and (more or less) quickly decide whether or not to act based on the new information.

When a person is considering investing in the stock market, they should start small and come to understand the rhythms of the market and of their specific stock picks. Individual companies may have a unique rhythm, based on earnings reports, changes in outlook, news items and large trades or participation in the market of strong and weak traders. This is the kind of benefit that comes from experience and can help a person gain a small advantage.