As featured in the Herald Sun – Friday 19th August 2016.
By David McCulloch – Market educator and consultant to Share Wealth Systems
How might Charles Darwin’s theory of Natural Selection have relevance to traders and investors in the markets today? Darwin observed that when environmental conditions changed, some species appeared more able to adapt to those changes and as a result survived, grew to maturity and were able to pass on those characteristics to the next generation. It also appeared that the simpler the organism the more likely it was to have the potential to survive those changes. Many of the most successful organisms have rather short lifespans (bacteria and viruses), and are able to produce offspring faster than the less successful ones and hence the term survival of the fittest.
The financial markets are in a constant state of change and it is important for the survival of the investor/trader that a simple methodology is used. Many inexperienced market participants feel the need to make things as complex as possible in the belief that it will protect them during times of change. One only needs to look back over the last 12 months to see the huge “environmental changes” occurring quite regularly in our markets. It is also worth noting that some of the most robust creatures have been on this planet for much longer than we have, for example reptiles such as the crocodile. Their ability to survive environmental changes has made them very successful over a very long period of time. Likewise, the simplicity and robustness of your investing methodology will help you to survive and outlast other market participants.
What does a simple and robust system look like? Simplicity can be built into your method by minimising the rules that are dependent on a specific set of market conditions. With conditions constantly changing, it also makes sense to explore a range of markets that also provides diversity. The key here is to find markets that are not highly correlated, and therefore are not experiencing the same level of “environmental change”.
There will always be certain conditions under which your methodology will work best and being able to recognise those times is important. The use of simple filters can help to make a method more robust if it can help determine those conditions. If the condition for investing is not suitable, the filter will clearly indicate this and capital will not be allowed to be invested. Remember, protection of capital is the first rule of investing.
Complex systems are generally that way because they have been designed to take advantage of market conditions that were noted during their development. The more rules that are added, the more the system becomes tied to those market conditions. Simple rules that are built on durable concepts such as trend, momentum, and relative strength should be the basis for any newly created investing plan. We can’t control the markets, but we can control the way we behave in response to those changes and as in nature, simplicity is a key to survival.
David McCulloch is a market educator and consultant to Share Wealth Systems.
