Reality Bites

Tate on Trading - Reality Bites

“Prediction is very difficult, especially about the future” – Niels Bohr

Traditionally, sensible traders are immune from prediction as either pseudoscience or art. We tend to leave that sort of nonsense to fundamentalists, astrologers and financial journalists who continually confuse ‘the economy’ with ‘the market’.

However, there is a certain brand of technical analyst who is also keen on trying to predict the future. You know the sort - their predictions are generally along the lines of this.
"Here might be the 5th wave of the 4th wave of the second last row in the No.72 tram, and if it is then, such and such, might go to whatever price. Or on the other hand it might be the 5th wave of the 4th lunar cycle and I need to find me a good looking goat."
In other words, "I have no idea but I do like the sound of what I am saying and if some peanut will pay me for it, all the better.
" In my opinion you are better off getting the neighbour's cat and punt kicking it over the fence. If it lands on its head you go long if it lands bum first go short and if it gets run over then all bets are off but the world is a better place.
Editor's note:
The views expressed herein are the personal views of the author and are not intended to reflect the views of The Trading Game regarding animal welfare and neighbourly relations...ah, who am I kidding...we laughed.

There is a further sort of technical analyst who sees the trading world as infinitely repeatable, and whilst I agree with this to a certain extent, my concern is with the very Newtonian view of the world that many have.
Where we differ is that while I agree that behaviours within markets will repeat because humans as a population are incapable of change and markets are driven by human irrationality, I don't see the trading universe as a giant clockwork mechanism which seems to be the preserve of many.
Lately this view has been expressing itself in a comparison between the 1974 market and the current market.
The line of thinking goes something like this. In 1974 the S&P500 took 91 weeks to lose 48% and in 2007 it took only 74 weeks to lose 56%. This coincidence is seen by some as a sort of spooky correlation and is the jumping off point for a series of predictions about where the market will go.

The 1974 recovery saw the market initially gain 43% in 42 weeks and this gain was extended to 64% in 104 weeks. Therefore, it is presumed that the S&P500 will follow this pattern and initially gain 43% or 375 points and terminate initially at 1041.
This move will then continue to 1224 and somewhere in here Fibonacci numbers or some such thing should get a mention. But I get enough emails from people who wear tin foil hats and wear Star Trek pyjamas so I'll leave that one alone for the time being.

The point being they believe the world is like a giant wind up machine with patterns repeating in perfect precision time and time again. Now markets do repeat in a macro sense – busts follow booms and vice versa but this is a wild chaotic pattern that is driven by human foibles.
The certainty of prediction raises problems for traders since it blinds them to the possibility that the prediction might be wrong. This in turn leads to a failure to play defence, which is in my opinion should be at the heart of all trading decisions.
If defence is not the central tenet of your philosophy then you will be less inclined to seek to protect your capital because you “know” what is going to happen.
Likewise you will fall into the old behavioural trap of discarding any information that contradicts your opinion and seeking out any information that confirms your opinion no matter how absurd or obscure.
Now these issues are present for traders on the best of days but to compound these problems with the notion that you know something with a high degree of certainty will only hasten your demise.

Prediction is an endeavour best left to economists and other sideshow hucksters while the rest of us get on with the business of being adults.

And the final word should be left to J.P. Morgan who, when asked for his prediction of the market, said that the market tomorrow will be the same as today – but different.
- Chris Tate

 

It used to make me laugh when people first learned statistics.

They would spend enormous effort analysing data to try to calculate to the 6th decimal place exactly how uncertain they were.

So I guess when you have spent (wasted?) so much time perfecting your model, you don't feel the need for that stop-loss or hedge as insurance against self-delusion.

Cheers,

Rob