This is a question most beginners struggle with. Their thinking goes, If we get a BUY signal the market is supposed to go up then why does it not go up every time?
To get a definite outcome every time we need to satisfy the necessary and sufficient condition for the outcome to happen. This is a mathematical concept. Necessary and sufficient conditions mean no other conditions are required for the outcome to happen.
When we get a BUY signal we have not satisfied all the necessary and sufficient conditions for the market to go up. The reason is we do not know all the necessary and sufficient conditions. What we do know are some necessary conditions. To make sure we know the right necessary conditions we test the outcome of the signal to get a 70%-80% success rate.
The next question is since we do not know all the necessary and sufficient conditions for the market to go up should we not take any action based on that signal. The answer is we should take action because the success rate of the signal is 70%-80%. Why do we want to miss this opportunity?
The way to take action is to validate your signal. If the signal gets validated you know all the necessary and sufficient conditions have been satisfied, without having to know what those conditions are.
To validate buy only 20% of your portfolio when you get a BUY signal from this blog. If your portfolio rises by 2%, then BUY another 40% of your portfolio. If it goes up another 2% be fully invested. When we get a BUY signal on the Market direction on this blog and the market does not go up, the market is telling us “not yet” – wait, because all the necessary and sufficient conditions have not been satisfied. So by validating the signal we let the market tell us if it is ready to go up. If it does not go up, we lose only a very small percentage of our portfolio.
This way we are able to follow a signal with a 70%-80% success rate and limit our downside risk.
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