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Making sense (and money) of[f] the Stock Market

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Before I begin, I would like to read a disclaimer.

I am not a financial advisor, and I am not professionally qualified to give financial advices. I am just a friendly neighborhood blogger who has learnt stock market all by myself. The analysis and tips I share on this blog is based on my personal investing experience and should not be considered professional financial advice. Before investing in any securities, kindly consult your financial advisor.

The middle-month Hypothesis

What you see in the chart above is the price trend of S&P 500 index for a period of three months, where each month is enclosed within the boundary of two vertical green lines. (Let us not ask which month this data belongs to because it is not relevant to the argument I am about to make.)

In the middle of each month, there is a significant dip in the stock prices (highlighted by red dots), and then an uptrend follows. The observation tells us that every mid-month there is a possibility of temporary index correction, and the pattern seems consistent for the timeframe presented in the chart. If you buy the index ETF during that time, there is a good chance that you will generate a good return in next fifteen days, according to this hypothesis.

If you think this is a consistent pattern, you can create a trading strategy around it and harness the herd psychology. This is what technical analysis is all about. Technical analysis is nothing but looking for patterns in the charts and making predictions based on those patterns. In a way you are betting on how a group of people will think and behave based on how they thought and behaved in the past. People’s behavior ultimately guides price action in stock market.

But hold on

There is no guarantee that the S&P500 index correct itself in the middle of every month. This is just a hypothesis that can easy be proven wrong. Let us test this hypothesis by looking at data from a different set of months.

You can clearly see in the chart above that Month 1 shows us a middle finger by disobeying our middle-month hypothesis. There are no significant mid-month correction here, and the entire month seems to be bullish, falsifying our hypothesis blatantly. It’s logical to say that depending on such analysis and trying to time the market (by buying at the middle of the month) is a bad idea.

A Bogus Science

The above exercise explains much of technical analysis in a nutshell. Much of what they sell as ‘Technical Analysis‘ is a bogus pseudo-science. A lot like astrology. (Well, astrology is worse), but you get my point.

Mainstream Technical analysis tends to ignore a very important truth: Past events are not indicative of future. A lot of people claiming to be gurus of trading based on technical analysis have no clue what they are peddling. Oh, look a hammer ! A sausage ! A hanging man ! A flying penis ! They see all kinds of magical patterns in the charts. Who are these people? Oracles?

These self proclaimed oracles of financial world will give you all sorts of illogical trading wisdom, and none of them are useful. A better option is to depend on fundamental analysis. Although fundamental analysis too has its flaws, but it much more grounded in logic.

(Note – when I say technical analysis is bogus, I am not discrediting the methodologies that analysts in the financial industry uses to study investment behaviors and make predictive models (I have been a financial analyst in one of the world’s biggest financial institution). I am saying that much of what is peddled in the name of technical analysis (by experts and amateurs alike) are completely based in fantasy and wishful thinking)

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Stock Market is a like a Ponzi Scam. But a good one…

We know that keeping money in the form of cash is problematic. The rate at which money is created is greater than the rate at which goods and services are produced causing inflation.

Inflation is a real money killer and people fear it. To protect themselves from inflation, many of us choose to invest our money. The important question is: What avenues are available for investment? Should we buy stocks ? Or bonds ? Or gold ? OR Fixed income instruments? Or Turtlecoins?

And the answer is

The best investment is an ‘imaginary idea‘. It is a valuation that people assign to an asset based on “opinionated” numbers.

One of the most significant factors that give importance to an asset is the assumption about potential cashflow they will accrue in their life time. A fixed income instrument with a face value of 100 that pays 10 percent will generate 159.37 in interest payments over a period of 10 years (compounded annually).

Similarly, the cashflow a stock will generate in 10 years depend upon how much profit it makes during that time period. There are many execution risks that can prevent a company from achieving the profit goals, but a carefully calculated CAGR can be used to create a good projection of future profitability by taking some margin of error into account. It may sound esoteric to you if you don’t know how fundamental analysis works. But don’t worry because I will give you a much easier way of making stock prediction so keep reading !

Index ETFs to the rescue

Stock market is a perfect Ponzi scheme, and you can take advantage of this structure to make money without being a called a fraudster (cuz this Ponzi is completely legal baby ; ) ).

When you buy a stock on the exchange, you are basically giving your money in exchange for an asset (the stock) hoping that it’s price will increase. The only way it’s price will increase is if someone is willing to pay more than what you bought it for. This willingness is determined by the expectation of the company’s profitability. The money you make depends upon the infusion of new money into the stock (remember stock market is Ponzi scheme where capital increase is function of capital inflow often based on often wishful assumptions about a company’s future profitability).

Predicting the future profitability for a company with good accuracy involves complex fundamental analysis, and most of us simply don’t have the bandwidth to do it ourselves. A better option for many is to invest in an index ETF like S&P 500 , which offers a good opportunity to benefit off this Ponzi scheme.

A little bit of central Banking

The money supply in US (and in most countries) is controlled by central banks, and the US FED’s responsibility is to carry out the congressional dual mandate : Maximum Employment and Price Stability.

By creating temporary inflation, the FED is able to boost economic growth. If the economy is growing it means that money supply is growing. More money in circulation means more money entering the capital markets.

The fate of S&P500 index lies in the hands of US economic growth. To determine if S&P 500 will continue to grow or not, you need to determine if economy will continue to grow or not. The infusion of new money into the Ponzi scheme (stock market) can happen only if new money is created. And new money is created when economy grows.

If you don’t know how the monetary system and the economy works, you can depend on economic forecasts by reputed agencies that gives out projections about US economic outlook. You can also make use of online resources like tradingeconomics.com. The below chart shows the GDP ( a measure of economy) over the years:


source: tradingeconomics.com

Despite the bummer in 2020 due to covid-19, the outlook for US economy looks positive according to consensus reports. Things will be back on track and the economy will continue to grow. A growing economy means more money in circulation and higher corporate earnings. These factors drive S&P500 higher because they are the leading indicators for long term price trends.

S&P 500 is like a Ponzi scheme that is not ending soon because there will always be new investors infusing fresh money into it perpetually as long as the population grows. The money that they will earn through their hard work will push the S&P500 higher. These young investors will get the stocks from us and we will take their hard earned money and retire. And this cycle will continue. The millennials will pay for baby boomers. The Gen X will pay for millennials and so on. This is a perfect financial plan unless there comes a black swan event that takes the US economy down.

The Takeaway

If there is any takeaway that you should take away from this blog post, it is that ETFs like S&P 500 are very good investment for many people who don’t want to get into complex stock selection process using fundamental analysis. In the long run, the returns on S&P500 is going to beat inflation and help you retire with a good corpus of cash. But again only if the US economy and the money supply continues to grow. I regularly invest in S&P 500 because I am betting on US economy, and I believe it is going to do great in coming few decades. If you learn to analyze the economic outlook, the strategy for investing in index funds will come naturally to you.

Good Luck !

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