Making Sense Of The Markets
Making Sense Of The Markets
When a person decides to enter the financial markets and learn
to trade, they bring years of personal experiences with them.
Those experiences are usually a detriment to profiting as they
are based on one's life experiences. The financial markets, as
well as all freely traded markets from stocks to commodities,
from currencies to tulips, behave in a much different manner.
Typically, when we first learn how to trade, we study the
markets and try to develop our own personal theories about how
the markets work. Because we don't actually conduct formal
experiments though, we fall prey to psychological biases. Those
same personal experiences, built over a lifetime, which helped
us to advance and learn in our world, wind up being the very
reason most traders fail to profit.
False Consensus Effect
One of these psychological biases is the false consensus
effect... we tend to wrongly think that others believe what we
believe and do what we will do, but that's only our perspective
and it can mislead us.
Why is it difficult to anticipate what people will do? Part of
the problem lies in the fact that we are mere mortals. Humans
have a limited capacity for understanding complex information.
In some ways, people can process information better than a
computer, but in other ways they cannot.
The false consensus effect is one of those rules of thumb that
may bias our decisions. No matter what decision you ask people
to make, no matter how important the issue, and no matter what
choice is made, social psychologists have demonstrated that
people over-estimate the number of others who agree with them.
"...you can't always anticipate precisely how people will react
to world events. It's all a matter of having the right
perspective, and it can be hard to find that perspective at
times" There is a natural tendency to believe that our decisions
are relatively normal, appropriate and similar to what our
colleagues and peers would do in a similar situation.
We use our decisions as an "anchor" and evaluate what others
would do based on what we would do. Decisions based on "our"
life's experiences. Our biases. Our interpretation of events and
their consequences.
This decision-making bias can contribute to feelings of
over-confidence. Once we make a decision, we tend to be
confident that we are correct and that others will agree with
us, but had we seen the situations from their perspective, we
may see that they would behave quite differently.
Anticipating What The Masses Will Do
Market timing is often about anticipating what the masses will
do. Will they buy or will they sell? It can be hard to do.
Take the past several weeks, for example. With the war, the
hurricane(s), and high oil prices, one might think that the
masses would bail out of the markets.
But instead, for several weeks during and after hurricane
Katrina, the markets rallied. Now, faced with another huge
hurricane (Rita), aimed again at the Gulf coast and all those
oil rigs, the markets quickly declined. Same threat but two very
different reactions to them.
It goes to show that you can't always anticipate precisely how
people will react to world events. It's all a matter of having
the right perspective, and it can be hard to find that
perspective at times.
The Very Best Timing Strategies
The very best timing strategies have losses. The reason for this
is that the markets can not be predicted with certainty. Sure,
someone will make a good call and get lots of publicity, but
consistent correct predictions just do not happen.
It is the same with trading reversals. There is always someone
who predicts and perfectly catches a market reversal. But try
and do it consistently and you will quickly see your savings
decline.
So, when times like these occur, where the markets move up and
down with extreme volatility and with no apparent trend, you
need to sit down and recognize this for what it is.... a time
when no strategy will be able to make all of the calls correctly.
The Very Best Timing Strategies
But remember... and we wrote about this only a few weeks ago...
without following any strategy, you have chaos. You will lose
money..
Following a carefully defined "strategy" is the only sure way to
be certain we will be in the right position, at the right time,
when the markets take off in one direction, and stay in that
direction.
Unless history has forever been changed, a trend is in the near
future. It is critical that we be onboard it to profit. The only
way to ensure that we are, is to follow the strategy.