I give Michael Gayed a lot of credit – he is extremely vocal and clear about his convictions and when the data changes, he just as vocally shifts gears. As a tactical manager working in the public eye, his credibility is always under the microscope and as the manager of a mutual fund, his track record is always available for public scrutiny. Michael only popped up on my radar recently – his MarketWatch column is consistently well-written and he’s built a big following on Twitter seemingly out of nowhere.
In today’s guest column, he tackles a very important topic – the need to focus on process and letting the positive outcomes over time be a result of not panicking into a big mistake. I think you’ll enjoy and learn from this – JB
The Golden Rule
“The golden rule in the stock market is consistency in actions.”
– Michael E.S. Gayed
Over the past few months I’ve been working through my father’s 1990 book on Intermarket Analysis and Investing with the end goal of republishing it in his memory. The book helped form my analytical foundation when it comes to addressing broad market movement and identifying the conditions under which asset classes tend to outperform. The quote referenced above is taken directly from the last chapter, which I think is perfect in describing what’s happened thus far in 2013 to markets.
Towards the end of January, I began aggressively making the case that the odds were beginning to favor a correction in stocks given various intermarket trend movements. Those same movements historically tended to precede corrective junctures, as they did prior to the Flash Crash of 2010, Summer Crash of 2011, and mini-corrections of last year. The fundamental idea backed by academic research and our own backtesting is that certain areas lead the market one way or another before the market eventually follows. I likened the environment in February to driving in a snowstorm which, although it did not guarantee an accident or a crash, increased the odds of one for the Nouveaux Bulls.
At the time, our weekly-run ATAC models used for managing our mutual fund and separate accounts took gains in our stock allocations, and flipped to bonds. It looked as if a correction was about to take hold in mid-February as the Italian elections shocked markets. Bonds started catching a nice bid, and volatility began to soar. The outcome of a correction seemed ever more likely. Then, a complete reversal took place. Markets rallied, and all of the warning signs began to fade away, notably right after last week’s ADP report.
What did we do? We stuck to our process, as our models then took a loss in the bond trade and rotated right back to equities. Many who had been following the analysis seemed shocked by the move, failing to understand that markets are entirely about probabilities and never certainties. Yes – the market rose about 3%, making the outcome of a correction wrong. However, as my father correctly said, consistency in actions will over time matter far more than any single call or any single trade. The correction case was based entirely on price movement within the market. When that changed, everything else changed.
There are a few good takeaways from this most recent period which I believe are important to stress:
1. It’s okay to be wrong as long as you aren’t very wrong for very long. The worst thing is to be stubborn and override your process because you are emotionally invested in what you believe.
2. The expression “you’re only as good as your last trade” is incorrect. You are only as good as your process. One can get a trade right for the wrong reasons, and a trade wrong for the right reasons. It is crucial to distinguish the two for long-term success, and stick to your strategy.
3. It’s always a battle, even if you’re winning. We had a very good year in 2012 using our process, but mean reversion does happen even within trading strategies. Expect such periods, and accept them. What matters is that your mean is higher than it would be otherwise.
The bottom line? So long as you know your process and believe in it, that is what you must focus on. In markets, if you can control your process and your actions. Over time, the outcomes will take care of themselves.
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