Would You Invest in "the Math of God?"

Alexander Green
by Alexander Green, Chief Investment Strategist

It's something millions of investors wish for, a man with a system that tells you exactly when to buy stocks… or bonds… or commodities… or currencies – and when to sell them.

Many big name money managers claim that they have found just such an individual in Tom DeMark, founder and president of Scottsdale, Arizona-based Market Studies.

DeMark claims he has a system for predicting where markets will move, based, in part, on mathematical relationships that underlie the design of the Parthenon in Athens and the Great Pyramid of Giza. Markets, he insists, are moved by waves that crest and fall based on a series of numbers called the Fibonacci sequence and the closely related golden mean.

A bit of explanation is in order here. Fibonacci numbers appear in an infinite sequence… 0,1,1,2,3,5,8,13,21,34 … where each number is the sum of the previous two. Divide any Fibonacci number by its predecessor and the quotients will cluster around 1.618 – the golden mean or, ahem, "the divine proportion."

Sounds a bit nutty, right? Except a lot of entirely sane people are along for the ride. Subscribers to his service include some of the biggest names on Wall Street, including Leon Cooperman and Paul Tudor Jones. De Mark is consultant to Steven Cohen, founder of SAC Capital Advisor, which manages $14 billion. David Goel, managing partner at hedge fund Matrix Capital Management, says "When I use DeMark's work, I feel like I'm wielding Thor's hammer."

Cynthia Kase of Kase & Co, a firm that offers trading and hedging advice, is even more enthusiastic. "This mathematics is embedded in the structure of the universe," she says. "It's one of the reasons I believe in God."

When the Creator of the Universe offers trading advice, who doesn't take it? Michael Shermer, for one.

Shermer, publisher of Skeptic magazine, columnist for Scientific American and author of The Mind of the Market, would call this "patternicity," the tendency to find meaningful patterns in meaningless noise. In almost every aspect of our lives, we try to connect unrelated dots to create meaning. But sometimes random dots – as on a technician's chart – are just that, random dots.

"There's a golden-ratio mania, and most of it isn't based on any kind of fact," says George Markowsky, a computer science professor at the University of Maine who holds a Ph.D. in mathematics. "It's amazing to me that adults take this stuff seriously."

Warren Buffett is another skeptic: "I realized that technical analysis didn't work when I turned the chart upside down and I didn't get a different answer."

Of course, the real reason pure technical analysis can't tell you when markets are about to rally and when they are about to fall is because the future, surprise, is largely unknowable. Yes, anyone can make predictions and point to successful outcomes. But what system predicted market-moving events like Saddam Hussein's invasion of Kuwait, the blow-up of hedge fund Long-Term Capital, or 9/11?

None.

What's more, when you ignore or discount company fundamentals you tend to run off the tracks. For example, DeMark recommended a buy on Research In Motion (Nasdaq: RIMM), the Blackberry maker, on February 18, 2011 as it hit $70.54. It started to drop. Yet DeMark recommended it again in May and then again in June, July and October.

Today the stock sells for less than $13. Anyone can make a mistake, of course, but this drop was no surprise to anyone who bothered to look at Apple's crowded retail outlets and RIMM's empty ones. While DeMark was busy studying his charts, the iPhone was having the Blackberry for lunch.

The takeaway from all this? Markets are unpredictable. Technical trading systems always fail in the end.

... And there's a sucker born every minute.

Good Investing,

Alex

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