Money doesn’t flow – it sloshes. Like water in a an overfull bathtub money moves in waves, as investors process information and balance competing desires to grow wealth and protect capital … As it sloshes, money creates a variety of measurable results, which signals how investors currently view risk and where they are placing bets.

The above metaphor works beautifully, as money movement is not linear. If it were, like any other thing in the universe, direction would be easy to predict. This is the essence of why it is almost impossible to predict market movement. In the smoothest of economic times, money moves from point A to point C and then back to point A and over to point B in order to maximize returns (grow wealth). In times of economic turmoil, protection of capital is the paramount concern, so money moves from point B back to point A, sits, and then slowly moves to point C, and if things calm a bit, back again to point B. In both cases, it moves in rounded waves emanating from different points. Picture two rocks dropped in a pond simultaneously …

We tend to think of everything in linear terms. All of Europe once thought if you traveled in a straight line, you would eventually fall off the edge. Until Einstein, we thought of time as moving in a direct line forward or backward. When analyzing markets, do not make the mistake of thinking money moves in a straight line, either in or out, or from here to there. It moves in all directions at once and to varying degrees.

The trick is to figure out how much money is moving and in which direction. It is not infallible, but this approach can help give you an edge if you view certain indicators within this frame. This is the major point of the book I recommended yesterday.

Shipley’s book discusses over 100 indicators in wonkish detail. My goal is to highlight a few of them to show you how each points to quantity and direction of money movement. The thing to keep in mind as we move through the indicators is that while one indicator measures quantity and direction of money movement in one area (options, for example), another measures the same in another area (bond market, for example). Remember, money movement is not linear (rocks dropped in a pond).

Tomorrow, I will discuss options and the measurement of volatility. Within this area are some of the strongest clues as to which direction the “money” is headed and how much is moving.