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Understanding Patterns: Key Rule for Successful Trading

Nikolay Stoykov
Managing Partner at Alaric Securities
Recognizing patterns is key to success in both trading and basketball. In this image, we explore the similarities between the two, using the analogy of a basketball play to help traders understand the importance of identifying patterns in their investments.

How Recognizing Dominant Patterns in the Market will Improve Your Trading Decisions

Understanding patterns is a crucial skill that is often overlooked in the education system. The lack of emphasis on recognizing patterns can result in significant waste and misuse of valuable resources. To illustrate this point, let’s explore an example that highlights the importance of comprehending patterns.

Understanding Patterns in Everyday Life: Recognizing the Dominant Pattern

It is a pearl of “common” wisdom that exercise and good nutrition are the cornerstones of growing up healthy as a child. And of course, they are, but just because you play basketball and eat well – odds are that you will not grow too much taller than your parents.

Nutrition and physical activity in the development of the body are essential, but the dominant pattern for height is the height of the parents (genetics). While severe malnutrition can cause stunted growth in children, changes in their nutrition levels – whether positive or negative – typically do not affect their height in the majority of cases..

Pattern interpretation/misinterpretation

Understanding patterns is key to accurate pattern interpretation. While patterns are generally true, they’re only true on average.

Genetics remains the dominant pattern for determining height, while all other factors are secondary. Of course, there could be exceptions where children grow a lot taller than their parents. However, in large populations such as towns or counties, children, on average, will be approximately as tall as their parents, regardless of the county’s wealth, location in Florida or Alaska.

So, playing basketball will not make you taller – playing sport, in general, might help, but it does not need to be basketball and do not expect miracles just because you suddenly become more active.

Miracles can happen, but it would be foolish to expect them.

Understanding patterns in the markets. Dominant pattern: money supply impacts inflation

Returning to finance, the high inflation of 2022 made most investors temporarily insane at the end of 2022, and many people were calling for double-digit inflation in 2023 and beyond.

What was the reasoning behind many of those extreme predictions. The common logic of ‘if something gets broken, it might never get While it’s true that some things remain unfixed once broken, there are also instances where repairs are made – although they may be temporary. Our experience shows that broken items usually receive attention and get fixed, providing temporary relief.

In the words of Milton Friedman,

“Inflation is always and everywhere a monetary phenomenon.”

To put it another way  – the dominant pattern/predictor for future inflation is money in circulation! It is not past inflation, what people are afraid of or think it might be, but money is in circulation!

As we pointed out in the article US inflation in 2023 at 1,3%? Is the Fed wrong again? our monetary model predicted very balmy inflation for 2023. And while inflation is still relatively high, it is much lower than most people expected.

Just like the allegory of weight – the dominant pattern for predicting your future weight loss or gain is not whether you have gained or lost recently. It is if you are in a caloric deficit. If you are in a caloric deficit – you will lose weight. It does not matter how much you have gained recently… Isn’t that obvious? To believe the opposite is childish.

In November of 2022, our monetary model for 2023 was pointing to a money deficit; hence we predicted the US would lose inflation or, as Mr. Powell called it – disinflation.

US Equities Markets and the dominant pattern for successful trading/investing

Now let’s focus on our favorite sector – US equity markets. The dominant pattern in successful investing seems to be

“Be greedy when others are fearful and fearful when others are greedy”
Warren Buffett

As we wrote in one of our previous articles,  Economic outlook for 2023: Don’t forget your Sun Screen, shallow consumer expectations made us consider that market most likely will go up in 2023.

Yes, you read that right – if all the talking heads on TV tell you to sell, you should buy. And if they tell you to buy, then…well, you should do the opposite.

Fortunately, you don’t need to start counting who is bullish or bearish on CNBC; what Warren Buffett refers to as “others” is actually consumer expectations:

understanding patterns

Most people will frown upon this simplification – investors are smarter than the average consumer. They could be smarter, but evidence suggests that as a group, most investors act just like the average consumer:

understanding patterns

Pictured above: Consumer Expectations (Blue Line), currently 53 – left scale. Dow Jones Average (Black Line) currently at 35 000 – right scale.

Predictive dominant patterns – a valuable insight for traders and investors

Investing history is replete with recurring patterns, and one of the most notable ones continues to repeat itself. People, even when brilliant (think Isaac Newton), tend to act irrationally and lose all their money when it comes to investing. Consumer confidence is near a 30-year low; the Sun will not rise from the West tomorrow, your children will not suddenly become geniuses, your parents-in-law will not fall in love with you suddenly, and… the Dow Jones will most likely not fall.

Theoretically, it is possible for the Sun to rise from the West tomorrow. Similarly, your children have the potential to become geniuses, and your parents-in-law could unexpectedly fall in love with you. Possible but highly unlikely.

Markets will go up, most likely, because of “the pain trade”; nobody is positioned for the Dow Jones to rise.

And that is a pattern. A dominant pattern.



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