web analytics

This post might make you mad. You might think I’m blind to risks or that I don’t understand the world. You might end up telling me how wrong and stupid my view are. That’s ok, because this post can also help you, and that’s what I’m trying to do here.

Over the years, one of the constants I’ve seen in the market is the anger from traders/investors who missed part of the move, or who were on the wrong side of the move. Social media is a particularly powerful lens to focus this kind of emotion–all you’ve had to do is to make a post somewhere this year saying something innocuous like “stocks might go up” and you would have been blasted with people telling you what an idiot you are. Let’s dig into this deeper: why do people miss moves? Why do they get so emotional about it? What can we do about it?

The only thing that matters

I wrote a longer post about this yesterday (just read it here), but let’s get this up front: the only thing that matters in the market is what you do–not how smart you are, how hard you work, what school you went to, what you are afraid of, what you hope for, what you believe–none of this matters. All that matters are your actions and how they line up with the movements of the market.

It’s not nearly enough to know the right thing; actions are all that matters. Doing the right thing at the right time is a supreme behavioral challenge, and the solution begins with knowing who you are as an investor and trader. This is not abstract, touchy-feely psycho-babble—not at all. Rather, the correct course of action depends greatly on whether you are a long-term investor or a short-term trader. Some of the most dire mistakes in markets come from taking advice that does not apply to your style or timeframe. For instance, a long-term investor should completely ignore signals that have a predictive horizon of a few days.

Why do we miss moves?

Have you ever wondered why, when you drive on a large highway, you never seem to be in the fastest lane? The reason is because you aren’t! If there are four lanes, there’s roughly an even chance that at least three of those lanes could be the fastest at any one time. You can only be in one of them, so you probably aren’t in the fastest lane. This principle applies to markets. Markets go up and they go down. Sometimes we will get moves, but sometimes we will miss them. (For those of you thinking “trend followers get every move and I know this because I read a book that said the only way to get every move is to buy every breakout”, even trend followers miss moves and get whipsawed.) To be very blunt: shit happens/

So, accept up front we will sometimes miss moves just due to chance, but there are ways to reduce these chances. This is where I think a disciplined technical approach (i.e., based on price movements of the market) really shines–it forces us to pay attention to what’s happening in the market rather than what we think. If you use an approach like this, you wouldn’t have refused to buy stocks in 2008 or 2009 because you were worried about (fill in the blank.) You would not have avoided buying stocks this year because of Brexit or your fears about Trump/Hillary/etc. Hopefully, you’d simply follow the system.

Chasing markets and trapped traders/investors

Markets moved when masses of traders change opinions or perspectives. For instance, a market might go up when people shift from neutral to bullish—having everyone bullish on a market is dangerous because, literally, who is left to buy? One of the things that can easily propel markets higher is having a group of traders who somehow missed the boat and now must chase the market higher. This certainly happens on a broad, institutional level, and has been responsible for much of the appreciation of markets over the historical record. So, if you feel that you somehow missed the move, know that even the best managers find themselves in this position.

There was a craze a few years ago focusing on failed technical patterns, assuming we’d profit from traders who were somehow trapped in these patterns. (I always thought that approach was naive because it assumed that markets were moving based on your technical patterns, but that’s another discussion for another day…) While there might be some truth to that, realize that markets also move when traders and large pools of money are trapped out of markets. Few things will propel stocks as surely higher as managers being underinvested at significant new highs.

What can you do about it?

First of all, if you are a long-term investor, then your job reduces to maintaining the appropriate degree of equity exposure for your life/business situation. A long-term investor cannot act on emotion, political opinion, or fears. The long-term investor must shut out the fear-mongering of the permabears and media commentators—warnings of impending doom make good headlines but make for poor investment decisions. Over any reasonable period of time, stocks go up, and, by making the choice to be involved in the markets, the long-term investor is professing faith that this will be true in the future.

A glance at the long-term chart of the S&P on this page shows a market in a clear and simple uptrend. Your job is to be long in this environment, and, yes, turns do occur. When they happen, you will miss the first 15% or so of the decline—this is simply the cost of being involved in markets from a long-term perspective. If you can’t accept that risk, you can’t be a long-term investor. (That’s the market’s rule, not mine!) However, there are spots where the long-term investor and shorter-term trader might find some common ground in tactical signals and shorter-term market movements. Often, the long-term investor can use inflections we identify for short-term traders, and simply buy. (Consider how the half-dozen buy points we identified this year would have left the long-term investor positioned.) Staying long in emotional markets can be difficult, but this is the task of successful investing from a high-level perspective.

sp long term swing

For shorter-term traders, the game is a little different. One of the keys to successful short-term trading is risk management, but a lot of other pieces need to fall into place (including actually having a method that works.) First, make sure your system has an edge, and then focus all of your attention on executing that system. For this trader, just as for the investor, realize that fear, doom, and gloom often masquerade as “analysis”, but it’s important to distance yourself from these things. The less emotional you are, the clearer you can see. The more clearly you can see, the better prepared you will be to act–and, at the end of the day–your actions are all that matters.

(This blog post is expanded from a piece that originally appeared in a research report I wrote for Waverly Advisors. We offer a free trial and invite you to take a look at our research if you haven’t done so already.)

(Edit: my work is now available at Talon Advisors.)