Tao Te Ching (Chapter 40)
Returning is the motion of the Tao.
Yielding is the function of the Tao.
All things come from being.
Being comes from non-being.
(By Lao Tsu, interpreted by Jerry O. Dalton)
“Returning is the motion of the Tao.” This line reminds me of the statistical concept of “regression to the mean.” In trading, this is illustrated by price being stretched like a rubber band to an extreme and then snapping back to an average price. On a larger time frame these snap-backs take more time. A common average is the 200-day moving average. A snap-back to the mean can be gradual and not necessarily reach the mean price. Technically, it is called “regression towards the mean.”
Some hedge fund managers use this concept on a multi-year level to manage their hedge funds. Although “regression to the mean” works best in longer time frames, it can be used with shorter time frames with some success. Like ocean waves, price may ebb and flow, but it always returns to a stable point, the Tao.
It’s important to yield to the ebb and flow of price. Fighting with the market only leads to unnecessary stress. Trading price waves is a lot like surfing. Fighting a large ocean wave only leads to a wipe-out. “Yielding is the function of the Tao.” The Tao is designed to promote yielding. And the Tao usually yields more than the 10-year note.