Market Noise or Why Recency Bias Hurt Us

In life, there is no second chance for a first impression. First impressions are the most memorable and have the biggest impact on our thought process. They subconsciously form prejudices and mental shortcuts that define our behavior.

The trading world is different. It is an environment, where last impression is often the strongest and has the biggest impact on decision making. We put tremendous weight on the short-term price action, while it often represents just noise. Because it’s easier, we’re inclined to use our recent experience as the baseline for what will happen in the future. We project the most recent events into eternity and make unwise decisions.

We strive to know everything about everything and make sense out of every move, even when it is a garden variety of noise. Sometimes we forget to take a step back and see the big picture. Zooming out helps to curb the frustration and clear the head.

If you intend to be in this business long time, you have to find a hassle-free way to manage your portfolio. Howard Lindzon has found it by focusing on longer-term social and business trends that are confirmed by price action. Brian Shannon has found it by focusing on day trade setups and being 100% in cash at the end of the day. Joe Fahmy has found it by timing his market exposure and swing-trading stocks with solid technicals and fundamentals. There are different paths to achieve the same goal.

Not everyone is willing to put the time and the efforts needed to define himself and focus on a specific approach. One of the lines from the original Market Wizards book that has remained vividly in my head comes from Ed Seycota. On the question, what would you recommend to the average trader, he replies: “Find a superior trader to manage his money for him and then find something he loves to do.” The trouble is that it is much harder to find a superior trader who will want to manage your money than to learn how to be consistently profitable yourself. Just because someone sounds confident, doesn”t meant that he will be able to deliver.


The Spike In Gold Is Not a Good Sign for the Stock Market

Gold gaining ground today has nothing to do with rising inflation expectations. On the contrary, it is quite the opposite. Spain’s 10 year  yield is climbing again. Swiss, German and U.S. Treasuries are rallying. There is only one explanation behind the rally in $GLD – it is currently playing the role of a “safe” asset in a “risk-off” environment.

The U.S. stock market is oversold on various measures, which doesn’t mean that it can’t become more oversold as nothing brings fear as fast declining prices. The silver lining of this correction is that we are entering earnings season with reduced expectations, which has usually been a good predisposition for positive surprises.

Even if there is a short-term bounce coming, we have entered a period of choppiness, where mean-reversion trades are likely to work better than breakouts.

$GLD rallying with $TLT is bearish for stocks. Once you see gold selling off along with the equity market, then we would be much closer to a “forced liquidation” period, which has historically provided great entries for long-term investors.

JPMorgan ($JPM) and Wells Fargo($WFC) report this Friday and the reaction to their earnings will reveal a lot about the near-term future of the stock market.

There Is a Difference Between Knowing and Doing

Empathy gap is the main reason behind most trading mistakes. Empathy gap is the difference between how you believe you will act under certain circumstances and how you actually act when the time comes.

For example:

– I want to grab that stock on a pullback to its rising 50-day moving average and then do nothing when the moment comes;

– I will buy this stock when it breaks out of this range on volume and when the time comes you don’t buy it, because the stock jumps 5% the minute it breaks to new high. You wanted to pay $50.25 and at $52 suddenly seems expensive. Then you watch it go to $60;

– I will short the crap of that stock when it loses that $100 support, but when it does, you don’t do anything;

– I am not going to chase that stock here. It is too extended and the risk to reward is not worth it and yet you still buy it because everyone you know is making tons of money in it;

– I will stick to my hard stops next time…

Most market participants have incredibly short-term memory. Greed and fear have the power to erase even the most well thought out plan and make the smartest people behave silly.

Ignorance is not the main hurdle. A lot of people have excellent understanding of how market works and what their biases are, but yet very few are able to put that knowledge into practice. It is the difference between knowing how to lose weight and doing it, but 10 times harder. This is why so many successful people are not afraid to share everything they know – the “secret” to their success. Most people will never put the efforts and the time to consistently apply that knowledge in their everyday trading/investing process. It is human nature.