With coffee in hand and still in my robe, I just watched a parade of authentic Native American canoes slide across the smooth water at the mouth of Discovery Bay toward a land mass known as “Protection Island.” The folks in those canoes are reenacting a tradition, one that has its roots in a culture that has long understood that stability in the system is the key to providing the necessary health for the community’s survival …

I just finished reading a lengthy treatise on the notions behind the economics associated with the policies of the US Federal Reserve. Admittedly, most of it made me want to go back to sleep, however, I find wading through the esoteric ideas of economic philosophies reinforces three guiding principles of my trading and investment life.

1)     Economists are not scientists.

2)     No economic system performs according to natural law.

3)     Economic stability is necessary for market health.

Of the three above principles, the last is the most obvious regarding making one’s money work in the market. The other two, however, are actually more important in understanding how to make one’s money work in the market.

The fact that economists are not scientists speaks to their credibility when they make economic or market predictions – little to none. Regarding number two above, well, it is the reason economists are not scientists. Science is about repeating experiments to achieve repeated outcomes, thus separating theory from hypothesis. Economic prediction is hypothetical not theoretical because in any economic system outcomes are dependent on the behavior of beings who often act independent of natural law. This creates irrationality, an unpredictable factor that makes consistently accurate economic prediction impossible.

This brings us back to number three above and that brings my thinking back to the Native American canoe parade I watched this morning while drinking my coffee. Protection Island is a federally mandated natural habitat, a wildlife refuge. Boats and people are not allowed within 200 yards of the island. Thus, the island and its surrounding water exist according to natural law. The stability of this system then allows for highly predictable outcomes.

Protection Island and the market are not similar in any way, but understanding the principle that creates stability on Protection Island helps one understand that when an economy is stable (when the irrationality associated with fear and greed diminishes), predicting market movement is much more reliable. Simply, market movement is ultimately dependent on the predictable ups and downs in an economic system.

The point here is that in the last four years, the US economy has been relatively stable and it continues to be so. Thus, despite the predictions of some economists, the market has behaved predictably, for the most part. Aside from some irrational periods of fear that made the market unpredictable, overall, it has tracked the general stability of the US economy.

The lesson here for beginning market players, and those who are not finding success because they give too much credence to economists and, for that matter, financial analysts, is too look to the economic fundamentals. I don’t just mean the week in and week out and the month to month delivery of economic data that is parsed and analyzed to death; I mean the macro picture that all that data creates. Below are two examples of the point I am making.

  • World shares traded near five-year highs on Monday as focus switched to an approaching wave of U.S. earnings after Shinzo Abe strengthened his power base, adding weight to Japan’s radical stimulus plans. The mood was also helped by a pledge from G20 nations on Saturday to put growth before austerity to revive the global economy, which the bloc said was “too weak.”
  • Blessed with the wisdom of understanding that long-term prosperity often comes as a result of short-term sacrifice, the new leadership in China (FXI) is opting for much needed restructuring to their economy and are willing to absorb the necessary pain in the meantime to make these changes happen. This does not mean that China’s leadership is going to allow their economy to collapse, however.

When reading the above, my “sense” is that the momentum in the global economy will increase, as Japan and China are the second and third largest economies behind the US, which has been and still is relatively stable, and stimulus will begin flowing back into the Eurozone.

Given my positive sense of the global economic future and looking at the data coming in week to week, month to month, my strategic approach to the market is less restrictive, meaning, as I see opportunity, I am more willing to make market plays and I am more willing to be looser with those plays.  

Something to think about …

Trade in the day; Invest in your life …

Trader Ed