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Stock Market Trends Are a Lot Like the Weather

My friends, family, and colleagues often tease me about my propensity for analogies.

We have always thought a good analogy can help take a complex subject and put it into terms that almost anyone can understand.

That is a "good" analogy; sometimes mine aren't so good – haha!

That doesn't stop me from trying, and whether it is sports, maritime, or the weather, we will keep trying…

This came to mind recently as I considered the role of "trends" in trading and investing.

A “trend” is defined as… “a general direction in which something is developing or changing.”

In stock market terms, it means the direction of the stock price.

There is no "official" definition of upward or downward trends, but—as Supreme Court Justice Potter Stewart once said about obscenity—"I know it when I see it."

I have always been intrigued by trends, which are essential to making big money in the stock market. Yet, it can be hard for investors to convince themselves to participate in them.

We partially discussed this concept earlier this week in HX Daily when we discussed participating in the stocks leading the biggest megatrends. You can read that note here.

The difficulty for investors can be that it doesn't feel "smart" to buy something already identified. 

Everyone wants to figure out something that no one else knows about. That is a very "sexy" idea, and it is excellent if you can accomplish it, but it is hard to do. If you ever do, you may do it only a few times in your investing career.

When thinking about trends recently, though, we began to think of an analogy. This one is about the weather.

We were thinking about making big money in stocks.

We have shared our views many times, but to make big money in stocks, you should look for companies that grow earnings. Grow them a lot.

The best way to find a company that will grow its earnings is to look for significant growth opportunities. Like the megatrends we spoke about earlier this week.

The weather analogy we want to use has to do with rain.

Certain climates are more prone to rain than others. If you like rain, then you should probably live in those areas. The geography and climate make it much more likely to rain there.

Where are the rainy areas in the stock market?

Through time the majority of them are in technology. 

That technology could be in hardware, software, the internet, or even healthcare. 

Indeed, the technology sector has driven the stock market's most remarkable growth in the last fifty years.

That doesn't mean there can't be significant growth opportunities in other sectors. 

Several awesome growth retailers have emerged over the last half-century, and we think there will be many more in the future…

Think of those, though, as finding the rainy part of an otherwise dry country!

What REALLY got us thinking about this weather analogy is that even in the rainiest areas, it sometimes stops.

Weather is not a function of "independent trials."

This is an essential concept in statistics and finance.

This concept states that the previous outcome does not influence each outcome.

In theory, flipping a coin should be an independent trial. While the probability of consecutive coin flips going in the same direction decreases as there are more in a row, the flips are entirely independent.

Some stock market analysts argue that stock price movements should be considered independent trials. We strongly disagree!

Stocks that are in long-term trends very often continue to go higher.

Remember that stock that goes up tenfold needs to go up two-fold, three-fold, and five-fold first.

If a stock is performing this well, it is usually because it sees good operations trends. It is growing and beating numbers. This invariably drives the long-term stock performance of the biggest stock market winners.

Even if a company is part of one of these significant trends – both operationally and the stock price – sometimes it never rains all the time.

Just like the weather, if it rains too much, the likelihood that we will enter a dry spell will increase. The atmosphere can use up all the humidity, and the rain will end—even in the wettest areas on the planet.

This is what can happen in stocks.

Even in the context of an awesome long-term trend, we can see buying build to such a crescendo that it exhausts itself. This will mean the stock is in for a "dry spell."

We now think of this as we examine the rocket ship chart patterns in many leading growth stocks.

Even though these are significant long-term trends, taking some profits is still merited!

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