One of the most fascinating aspects of trading and short term investing is managing
your own psychological biases. While this may technically fall under the wing of
sentiment analysis, today's TrendWatch is going to be a case study in why short term
traders may want to completely disregard certain data, no matter how compelling it
may seem. The data to avoid? Much of the media.
Why is that? It's often been said that, at least in terms of financial matters, the
media is usually wrong. That's not really the case, though, as the media is most
often right. Rather, the problem with the media is that their content is either too
late or irrelevant. And that's where we need to be careful.
I combed through some recent print media (the Wall Street Journal, Fortune, etc.)
looking for headlines and articles that could cause a trader to draw certain (yet
erroneous) conclusions. I'd like to review a few, just as an example of why it's
dangerous to use information that is not consistent with our investing style. This is
not a pan on those printed resources; they reported accurately. Instead, this is a
pan on those who assume that an obvious cause-effect relationship always exists.
October 14th, 2002. "Consumer confidence fell to a nine year low." - Wall Street
Journal. The most pessimism in nearly a decade, and this was even after the October
rally started. Would any reasonable person get into the market while thinking like
that? Between then and the end of November the S&P 500 gained 11.2%
November 27th, 2002. "The economy grew at a surprisingly strong 4% (annualized)...the
new data reinforced perceptions that the economy isn't headed back into recession." -
Wall Street Journal. Finally some good news to latch onto, as it was the strongest
growth we had seen in months. The S&P 500 lost 6.3% by the end of December.
January 6th, 2003. "the most plausible economic scenario for the year ahead...should
inspire not trepidation but modest optimism" - Fortune Magazine. Finally a light at
the end of the tunnel for investors? Through yesterday, the S&P is 10.4% lower than
it was at the time that was printed.
Again, in no way have these writers done wrong. The problem lies in the
interpretation, and there are two fallacies that we need to overcome. First, this
type of data is not directly useful to highly active investors. This is economic
data, and economic cycles typically last about four years - not four weeks. What's
your average holding period? Second, investors rarely do exactly what they should
'obviously' do. In fact they often do the opposite. This is why it pays to be a
contrarian in some cases (although you may be able to profit from the initial
over-reaction to news).
I challenge all of us to read, listen, and watch TV critically. Some of it is good,
while some of it is not. One question to ask yourself as you hear news is "How have
investors responded to this news in the past?". More than that, two questions you
must ask are "Does this apply to me and my trading style?" and "How ?".
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