The Red Wheel

I built the Red Wheel to help investors understand how and why market cycles repeat. In this piece, I explain the Red Wheel’s four everlasting cycles, and why ancient roots have modern branches.

The cycles on the Red Wheel are everlasting because each one has no beginning and no end. And each cycle has an easy part and a hard part. Knowing what to do at each stage of the cycle — and actually doing it — has separated the winners from the losers since the bearskin days.

THE only surprise in market cycles is that investors are surprised by market cycles. The major swings up and down seem so obvious, even necessary, in hindsight. As we have seen, inside the head of every investor lies the source of market extremes. And the process is no mystery. Normal human thoughts, emotional responses and simple herd mentality combine to move stock prices above and below intrinsic value, over and over again.

When you model this cycle, you draw a mood map of the market. In doing so, you uncover primal ideas that date back to the Stone Age. And in the past, you see the future. This is the Red Wheel.

Click image to enlarge

The Red Wheel

Stimulus: Uncertainty
The stimulus for cyclical change is always uncertainty. Because every day bring new uncertainty, and because uncertainly is intolerable, investors look back at what has happened — and they seek each other’s opinions — to decide what is most likely to occur next.

Uncertainty drives investors to find a point of agreement, a scenario they can believe in, in the hopes of making the best decision they can with the information they have at the time. While it seems like a rational process, acting on the mood of the day is a recipe for terrible investment results.

Response: Look Back and Extrapolate
At every point of the market’s circular motion, what we see are investors scrambling to figure out what’s going on. Their tendency, as they come to grips with the perplexities of the day, is to exaggerate apparent trends and project them on a straight-line basis.

For example, if the economy is strong, investors assume the country has entered a lasting new era of confidence and power. If the economy is weak, they fear the country could be walking the first mile down the road of total economic collapse.

In history and in nature, birth and death are equally balanced.

Thus every point on the circle produces a typical psychological state. Each state arrives in order, and investor behavior follows suit. In turn, the actions of investors move the market to the extreme points at the top and bottom of the circle. The cycle never changes, and the cycle always repeats.

Understanding the Red Wheel
The inside ring of the Red Wheel represents the most fundamental of all fundamental cycles, and that is the rotation of the earth, giving us day and night. It’s no surprise that one of the earliest symbols found scratched onto cave walls was the sun cross, a circle around a cross, like a hot cross bun.

Sun CrossThe sun cross can mean many things, but it often signifies the four points of the compass, or the four seasons. Taken as a wheel, the sun cross can mean the passage of time, like a sundial or clock. The time of day — especially mornings and nightfall — underlies numerous metaphors that investors use to relate to the stock market and the economy, and that’s why it’s part of the Red Wheel.

The second ring
The second ring from the center evokes the seasons. Here the familiar dualities of hot and cold, sowing and reaping, rags to riches, and feast or famine play in the mind. In Roman times the wheel was associated with the goddess Fortuna, the Bringer. A spin of her wheel could bring you prosperity, or bring you to your knees. Sound familiar? The Red Wheel is the wheel of fortune.

The third ring
The third ring from the center describes the typical human emotions encountered at each point in the cycle. As an individual investor, you may not feel like just one animal in a human herd. But your feelings usually reflect the mass mind, an enormous crowd of buyers, sellers and holders. The emotions of the crowd arrayed on the Red Wheel apply to stock market cycles, but it’s not hard to see the same feelings at work in other, older cycles, such as the rise and fall of politicians or paradigm shifts in technological revolutions.

What has been will be again, what has been done will be done again; there is nothing new under the sun.

The outer ring
Finally, the outer ring of the Red Wheel. This is the cycle to which we are personally most committed. It’s the life cycle of birth, growth, maturity and death. Here the wheel is a symbol of change, of transformation.

Sadly, all things must pass, including cars, houses, careers, relationships, businesses, ideas and entire civilizations. Fortunately, there is no shortage of new things to take their place. This idea is hard to get across to investors. The point of the Red Wheel is to remind investors that yes, bull markets get old and die, but just as certainly, they are born again. But when the market is high, investors don’t believe in death. Then later, when the market is low, they don’t believe in birth.

← The Four Stages of a Market Cycle

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