Understanding biases can not only help an investor refine his investment strategy but also time markets. The current short bias in the market gives us cues to whether the Nifty Bank will collapse, or will push up in Q3.
Predisposition and anticipation
The last time we mentioned Matthew McConaughey was in Fool's Gold. We happened to see the talented artist's work again as we sneaked in some time between two Euro Cup group matches to watch Two for the Money, a Universal Pictures movie based on sports betting.
It all seemed like a familiar scene, the only difference being that it was the result of a super bowl match which McConaughey (Brandon) was anticipating while Al Pacino (Walter) was predisposed to gambling.
Two characters of the same story, one anticipates and the other predisposes. One had intuition, rules, reasons, knowledge and skills while the other was reckless, betting everything on a game.
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The other guy
One of the first things our guru told us was that market is not a casino. But little did we know then that the probability skill we were learning had a high chance compulsive gambler, as the counterparty.
Things became clearer, as times passed that it's not just about learning to drive the forecasting and calculated bet car, but also to take care of the reckless drivers on the capital market highway.
Peter Bernstein, economic historian says that for most of history, in terms of business decisions, the world was agricultural and risk was in weather. And we can't do anything about the weather. But when we got into capitalism in the 17th and 18th centuries and markets began to function, the risk has moved from weather to what will the other guy do?
That's what the whole stock market is about. It's the other guy that not only brings risk to the system but also changes how markets work and function. Understanding his biases hence becomes key to success.
Bias
What are biases? Biases are false judgment, which lack objectivity. And biases increase or enhance after real money is involved. These emotional fixations are driven by crowd emotions and are different from independent thinking. It has also to do with personal experiences.
A failure or winning colours our investment approach to market. A failure makes us more risk averse, while a win makes us take more risk. One method is to get out of the market and reassess.
Markets do not tolerate inflexibility. It trashes it. Removing a bias is difficult, because we are influenced by events and news around us. A study of history is a good technique.
Frederick II, Holy Roman emperor and king of two Sicilies was a confirmed skeptic, refusing to accept data that he could not verify. It was in Frederick's court that Leonardo (Fibonacci) was interviewed on mathematical problems in 1220's when Europe was struggling with mathematical rationality and objectivity. An objective man in such times is an exception.
The expert bias
Oil will go to $200, Citi and GM are negative, Crisis is coming are some recent expert calls. First and foremost the experts appear late on the scene. Second, experts have bias too. But the problem is not just the experts, but our inability to really judge accuracy.
In time, all calls and forecasts are forgotten. And we don't really look for an expert to tell us something we don't know, we are more interested in him (her) telling things we know. It's like if you are an oil bull, the oil expert comments about $200 per barrel will be more credible. Or for example financial sector meltdown is all over the place, the reason why the Goldman Sachs call on Citibank's negativity might be true.
It's more about our preconceived positive or negative bias that we want to enhance, not even once challenging or questioning why these same experts did not tell us at $40 where oil was heading or telling us a year back that Citi or GM stocks might crash. Now that we are at 10-year and 30-year lows for Citi and GM, it's easy.
The permanent bias
Making money on trading is tough, or trading both sides of the markets are tough. As we suffer from certainty, linearity, straight line, extrapolation and positive bias. That is why brokerages are in business when markets go up and out of business when markets stagnate or go down. Their profile is linked with market upside not downside. A majority of us suffer from permanent bull bias.
Nature has no straight line, but if the stocks are going up today, they will go up tomorrow. If stocks are falling today, they will fall tomorrow are biases we don't challenge.
It can also be called as the order bias. If there is order, things are correct and when there is chaos, it's the global economy, the interest rates, the food, oil, currency or politics. A majority of us suffer from a permanent bull bias. There are a few who thrive in falling markets, but there are few of them with permanent negative bias.
Event and cause bias
A cause is linked with an event, is a bias. If you have the right information, you can profit. The information arbitrage days are over. Knowledge creates a bias linked with overestimation of skills.
Before and after we started the markets, the unknown was always greater than the known. And information and cause can never explain the event. The bias creates an illusion. Hamilton Bolton, a wave theory specialist said that it is not the news but the construction placed on the news by the market that confirms the trend.
Nifty bank bias
Markets predispose us to sector leaders, like banking did, and banks were the favourite. 50 per cent down, the predisposition is telling us to trash all the banks.
But anticipation tells us that 50 percent retracements, more than 6 months of one sided fall, clear five wave structures down, previous fourth wave supports and experts coming out now and warning of a coming crash after the chips are half in value is creating a strong negative affinity.
We are again in minority, like we were on Oct 22 when we wrote "Crash and Cash Cycles" where we highlighted the need to be in cash before the crash. "We see a lot of unsustainable greed," we said. Now the question to ask is that are we predisposed to a banking collapse or will the impending panic now create the best time to buy banks for Q3?
Three months of rise in a year, can give the key edge between a performing and losing portfolio. For us at Orpheus the banking collapse started in Jan 2008 (India Outlook 2008) and the coming perceived collapse of Nifty Bank, should give us a panic culmination.
We don't see the NIFTY BANK pushing below psychological 5000. Let's see how good our anticipation pans out, predisposition, we have none. "Am I biased?" is a million dollar question which we would like to ask every trading day of our life.
The author is CEO, Orpheus CAPITALS, a global alternative research firm
