## Dancing with the Trend

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I honestly cannot remember taking a course in high school or college specific for statistics.  I would imagine it was taught along with the many math and engineering courses I struggled through.  There was nothing like a draft card with a low number to motivate the successful completion of college in the late 1960s.  I can look across my office at the large bookcase and see 9-10 statistics books, plus a few forecasting (uses lots of statistics) books by Spyros Makridakis.  If you haven’t read any of Makridakis’ works, and you like this stuff, I strongly recommend him.  I remember in the mid to late 1980s, my friend and partner (he might not call it that) Norman North built a statistical analysis software product that used the US Business Cycle Indicators database.  You could compare various time series, most were monthly or quarterly, calculate linear regressions, and in fact, do polynomial curve fitting on any series or ratio of two series and offset one by any number of periods (usually months).  I remember looking at retail sales and offsetting it by 6 months with corporate profits, thinking it would yield my long held belief that one would reflect upon the other.  It didn’t.  And yes, a fifth order polynomial fit which is then extended somewhat into the future really looks like you have struck gold, except it rarely played out that way.  Sure was convincing though.

Chart A is a chart showing the annual returns of the Dow Industrial Average each year from 1897 to 2013.  The decile distribution of returns shows the positive returns in green and the negative returns in red.  Visually it is obvious that there are more positive (green) numbers than red ones.  Quite a few more returns are green and you can almost imagine where the mean is located, somewhere near the 10% column.  In fact, there are 77 positive years and only 40 negative years.  So, 66% of the time in the last 117 years the Dow Industrial Average was positive for the year.  Not bad, huh!  This is why you are always hearing that the market is up on average about 10% a year.  Sad commentary, using an average for 117 years.  I smell another article there.  Let’s play a game!  Some might think we just did.  First of all it is a fair game.  It is \$10 to play and you can play as many times as you want.  If you win, you will get \$1,000,000.  The mathematical odds of winning are one time out of six.  Seriously the odds of winning are 1 out of 6 times.  No tricks, honest.  How many want to play?

Chart A

The game is Russian roulette.  Now, how many want to play?  Hopefully no one.  What happened?  I changed your focus from those goofy statistics to the risk of playing and you realized you didn’t want any part of it.  This is exactly why you should always focus on risk in the market. Some might challenge this in that to win at Russian roulette you had odds of 5 out of 6, but that was almost too good to believe and I wanted to hook you right off the bat.  I know I have beat this to death in previous articles but I strongly believe most do not give risk enough consideration.  The financial media bombards us with statistics all day long.  They say the market is up today and has been up for the last six days.  Does that offer anything of value?  How about this:  the market has been up 5 of the last 8 days?  Just noise.  While this might seem important to some, I cannot imagine a real technical analyst finding it anything but an interruption, that is, if you even bother to watch the financial media.

I have beat up statistics quite a bit here, but will certainly yield to using them for learning and understanding how markets behave.  I just don’t think they should be part of an active investment process.  They can certainly be used to assess an investment strategy or process, but please make sure you use them in a manner that reflects your investment horizon.  Using 85 years of statistics when you have only 20 years to invest can be very misleading.   In my opinion, statistics is a perfect example of observable information; you just can’t make a trading decision based upon it.  Remember, you’re hopefully trading with real money; if not then statistics can be your friend.

Greg Morris

About the author: has been a technical market analyst for over 45 years ranging from analysis software development, to website analysis and education, to money management. He has written four books: Candlestick Charting Explained (and its companion workbook), The Complete Guide to Market Breadth Indicators, and Investing with the Trend. A graduate of the Navy Fighter Weapons "Top Gun" School, Greg is a former Navy fighter pilot who flew F-4 Phantoms on the USS Independence.  He also holds a degree in Aerospace Engineering from the University of Texas. Greg has a long history of understanding market dynamics and portfolio management. Learn More