Trading Places and the FTSE 250

“Be Fearful when others are greedy and greedy when others are fearful” – Warren Buffet

Randolph Duke: Exactly why do you think the price of pork bellies is going to keep going down, William?

Billy Ray Valentine: Okay, pork belly prices have been dropping all morning, which means that everybody is waiting for it to hit rock bottom, so they can buy low. Which means that the people who own the pork belly contracts are saying, “Hey, we’re losing all our damn money, and Christmas is around the corner, and I ain’t gonna have no money to buy my son the G.I. Joe with the kung-fu grip! And my wife ain’t gonna make love to me if I got no money!” So they’re panicking right now, they’re screaming “SELL! SELL!” to get out before the price keeps dropping. They’re panicking out there right now, I can feel it.

Randolph Duke: [on the ticker machine, the price keeps dropping] He’s right, Mortimer! My God, look at it!

Movie aficionado’s will know that this excerpt is from the movie Trading Places (1983), with Eddie Murphy playing the role of Billy Ray Valentine.  He’s explaining that the drop in pork belly contracts will continue down because panic has set in with the sellers and the buyers are waiting.  Fear is one of the more significant behaviors that drives markets, and one that is repeated every single day.

When the stock market is rallying and all we see is green, the market is deemed safe and a good bet.  Even though investments on the long side are becoming less and less cheap, more people jump into these markets as buyers.  At the extreme, your Mom joins a stock investing club thinking that they can’t go wrong in this market.  When the markets are plummeting and securities are actually becoming more and more affordable, the markets are considered more and more risky.  Buyers disappear, cash moves to the sidelines and fear sets in.  An up market gives us a false sense of security, and the overwhelming opinion is that these conditions will continue.  When the market is falling, panic takes over and selling proliferates.

Warren Buffet’s quote at the top of this week’s market call sounds simple and easy in practice, but human behavior gets in the way of most investors being effective contrarians.  Panic and Fear, or on the opposite side Euphoria, exist every day in the markets.  The more subtle instances of human behavior, like securities being Oversold or Overbought, occur thousands of times a day and define opportunities in the markets.  What makes it difficult for us to take advantage of these opportunities is that “oversold” and “overbought” are very subjective.  That difference, in part, makes markets.  It is also because we are wired to disregard the warning signs on the way up and the reassuring signals on the way down.

The power of pattern search technology (EidoSearch) is the ability to objectively identify the markets and securities that are exhibiting consistent patterns of investor behavior.  We are able to alert our clients to these patterns as OPPORTUNITIES, where investors can apply their experience to the data and determine if an opportunity exists or is worth pursuing.  It provides a starting point founded on statistics.

EidoSearch looks at millions of price, volume and economic patterns every data to objectively identify the trends that are most susceptible to consistent human behavior, and that can lead investors to great new opportunities in the markets.  Here’s an example:

We took a look at some of the major global market indices over the weekend to identify the markets that represented the best investing opportunity.  Meaning, we looked at the current 3 month price trends in these markets to find the patterns where investors reacted very consistently to the current trends historically, as an objective starting point on how they are once again likely to react over the next 1 month.  One of the most positive was for the FTSE 250 (MCX).

The below chart shows the 3 month pattern and 1 month forward projection for the FTSE 250.  We found 10 similar historical instances of the current 3 month price trend looking at the FTSE 250’s history (oldest was 1988), and the average return in the next 1 month was 3%.

The below chart shows the performance of all 10 similar historical instances of the current 3 month price trend in the FTSE 250, and how the index performed in the next one month.  The only down occurrence was in the Spring of 2000.

Replicating the Market Call in EidoSearch (Subscribers Only)

• Go to New Search tab and click “Indices” in the drop down (top button to the right)
• Type in MCX as the symbol and hit Enter
• Then hit the 3 month button at the top of the chart
• Hit “Search One” button at the bottom of the chart to search this current trend just against the FTSE 250’s history