How to Invest With the Power of Human Nature

Editor's note: The market can be unpredictable... But if you understand history, you can make it work for you. This type of analysis is at the core of Greg Diamond's Ten Stock Trader newsletter. Today, we're revisiting an essay he first shared with us in April 2018. In it, he explains how focusing on what's proven to work – without getting caught up in the why – can be a powerful trading tool... especially during times of market volatility.

"Human nature never changes..."

"History repeats itself..."

These adages stick around because they're true. They even apply to the market.

Market swings are nothing more than the graphic representation of human behavior... expressed on a chart of buyers and sellers.

And this market behavior tends to repeat.

That's how technical analysis works. We know what's happening because we've seen this all before.

Today, I'll explain more about how we can use this to our advantage as investors...

Here's a perfect example of a type of technical analysis that warned of a storm brewing at the start of 2007... well before the market crashed in the financial crisis.

It's called "intermarket analysis." This idea is based on correlations between asset classes. When one of these asset classes turns down, it may be a warning sign for other asset classes (in this case, stocks).

We know this because these chart patterns have shown up before, and those other assets have fallen.

Take a look at this chart. It shows the relationship between the S&P 500 Index (in black) and U.S. 30-year interest rates (in blue), right before the financial crisis...

The S&P 500 and U.S. 30-year interest rates traded in tandem for much of the early 2000s. Then, in late 2007, the correlation broke down. Interest rates started to turn down – a sign of a slowing economy.

Look at the red line...

See how stocks made new highs, while interest rates failed to? That was a warning that something was wrong.

Of course, most analysts at the time pointed to strong earnings and solid "fundamentals."

The ultimate fundamentalist – former Federal Reserve Chairman Ben Bernanke – proclaimed the effects of "the subprime sector on the broader housing market will be limited and [that he did not] expect significant spillovers... to the rest of the economy or to the financial system."

You know what happened next.

This is the essence of technical analysis – understanding the behavior of markets and history. This concept is lost on many investors. They just don't understand and aren't willing to put in the necessary time and effort. So they simply write it off.

Technical analysis is much more than trend lines and charts. It's understanding the past to profit in the future.

I'll be honest...

It took me a while to grasp technical analysis. But time and time again, I've witnessed how well it works.

I want you to see much more than the trend lines and patterns. Understand that we're studying the behavior of market participants... and learning from history.

And to do this, we don't need to speculate about the reasons behind the behavior. We don't need to worry about fundamentals.

There's nothing wrong with wanting to know why a certain stock will move... But I'm much more concerned with when that stock will move and what the price will do (i.e., how much it will go up or down).

And think about what really matters in investing – WHEN you buy and sell. The why is less important when it comes down to the goal of investing: Did you make or lose money?

That's all that matters.

Perhaps the greatest value in technical analysis is that it's both a trading strategy and a risk-management system wrapped into one. It shows us opportunities – and warnings. And it keeps us focused on making and preserving wealth.

If you're like most people, this is likely a brand-new way to look at the market. So it's going to take some time to get used to.

But once you understand the basics, I promise you'll begin to invest in an entirely new way... and eventually reap the benefits.

Good investing,

Greg Diamond, CMT

Editor's note: Greg's analysis shows we're nearing a rare trading setup right now... And he's more excited than he has been in years. While most investors will be caught up in the violent market swings ahead, Greg's strategy can help you use the volatility to your advantage – with opportunities to double your money or more... Get the full details here.