trends are more persistent in the real prices. Since the reconstructed prices have been generated by a totally random selection from the pool, this means that trends are subject to less random behaviour in share prices than would be predicted on the basis that the daily or weekly changes which go to make up the trends have a high random content. It is this increased persistence of trends that will enable us to make profits out of investment in shares.
Because of this increased persistence in the trends, and because of the fact that daily and weekly price movements, although having a high random content, do not have a 100% random content, then probably 70% of share price movement is not random, and is therefore predictable if the correct techniques are applied. The analysis of cycles in share price data, discussed in Chapter 6, also confirms this as a ball-park figure for nonrandom behaviour.
The technique of channel analysis, especially when used in conjunction with moving averages of various types, is able to extract most of this predictable movement from the share price data, thus giving the investor the most powerful prediction technique currently available.
We can predict the start and end of these price trends with a fair measure of success by adopting a realistic approach of developing “prediction boxes”. This means we do not say “the price will be 285p on 17th November 1997”. We do say “the price will enter the prediction area at the beginning of November where the downward trend will have an increasing probability of reversing direction, with the lowest price being in the range of 280p to 290p”. The difference between these two statements is the fact that in the first case we would be totally positive about a situation that it is impossible to be positive about, whereas in the second case we are taking into account the partially random nature of trends. Another important point is that the further into the future we try to predict, the greater will be the error involved in this prediction. The fact of the matter is that we do not need to know approximate price movements more than about three months ahead. This will be perfectly adequate for making substantial profits, as was discussed in the last chapter.
It is interesting to see how seriously some sections of the press take the idea of long-term prediction of share prices by some of the gurus of the industry. Just prior to the start of each new year the business sections of the quality newspapers always poll a number of analysts for their predictions of where the FTSE100 Index will be at the end of the year. Be assured this is not done as a little bit of Christmas fun, since both the columnist and the guru being polled seriously believe that this is a worthwhile exercise. They are saying between them that they know exactly what you out there will be doing on the investment scene in a year’s time! Just keep cuttings of these predictions and have your own bit of fun reading them in the future.
At some points in share price histories different trends will be featured particularly strongly, while at other times the price just seems to meander along with no apparent direction. Quite obviously, shares that move in the latter fashion will be useless to us as investors, since we will not be able to predict any future price movement. On the other hand, shares where the trends are readily observable offer the possibility of using predictive techniques in order to determine the best buying and selling times for those shares. Since there are so many shares quoted on the stock market, there will be no shortage of shares which fall into this category. We will show in this book that such is the diversity of shares that it will be possible to remain virtually fully invested, since when the time comes to sell one share, another will present itself as a good buying opportunity. It will not even be necessary to keep track of large numbers of shares. The 100 shares which comprise the FTSE100 Index, plus the shares which form the mid-250 Index, will provide plenty of opportunity. A further advantage to the investor in staying with these 350 shares is that the spread of prices, i.e. the difference between the buying and selling price of a share at a particular point in time, is much less than is the case with the shares of companies which have smaller capitalisations.
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