Continuing with the Eight Traits of the Insightful Investor…
The Insightful Investor does not confuse organizational and individual behavior.
Here is an example from today’s news – a quiet market day in a pre-holiday period before a Fed decision. Here was the summary:
Investors reluctant to make decisive moves a day before hearing whether the Federal Reserve will begin curbing its monthly asset purchases in 2013.
We all understand that the journalist wants to find a single-sentence summary. This is often an over-simplification, or imputing causation when movement was merely random noise. There are pages and air-time to fill. Usually it is harmless, especially for investors who are wise enough to ignore it.
Today’s summary is a bit different, including a very common mistake – treating the market as an individual investor or trader. Today’s trading included a level of volume consistent with the last few trading days, as you can see from this chart of NYSE volume:
Some of these days were up, others were down, and today was flat. You can see this from the chart.
The error comes from aggregating the behavior represented in hundreds of thousands of trades and interpreting it as a single investor. Each day’s trading represents many decisions. On a given day, the following behavior is included:
- Those who have decided to increase investments, perhaps deciding that the rally has legs.
- Those who have decided to sell everything, perhaps deciding that there is a bubble. (Maybe they just discovered ZH!!)
- Those who shifted from other asset classes to stocks.
- Those who sold stocks to buy gold or Bitcoins.
- Those who needed cash for personal reasons.
- Those who came into new-found wealth (inheritance, lottery, business sale) and decided to invest.
- Those who have been waiting patiently for a stock to hit a buy (or sell) target.
- And many similar stories….
On any given day, the net result of these decisions translates into a move in the overall market. When the summation is close to zero, it definitely does not reflect caution or inaction. The trading volume was the same as on prior days. It just happened to balance out.
The same mistake occurs when the market goes down and some pundit says, “More sellers than buyers.” Why does this faux wisdom get attention? The number of buyers and sellers always balances.
This also happens when people ascribe a single motive to an organization:
- Congress wanted to reduce sequestration. Wrong. This may be the final outcome, but there were dozens of different motives behind the votes.
- The GOP chose to focus on ObamaCare. Wrong. Perhaps true for some Republicans, but definitely not for others.
- The Fed is ready to start tapering. Maybe. The Fed decision is the result of a vote of members of the Open Market Committee. In the Greenspan days, everyone stayed on message. Now it is different. Many of the speeches also come from non-voting members. While nearly everyone agrees that the Fed is about to reduce the size of monthly bond purchases under the QE program, the exact timing is not known.
- Do not place too much weight on a single day’s trading. The best methods all provide a filter, separating signal from noise. Even hundred-point moves in the Dow are not very meaningful these days, representing a volatility of 10 or so.
- Beware of imputing causation for each day’s trading.
- Stay on your own mission. If you have a stock you are looking to buy (or to sell), take advantage of the random moves to implement your system.
This piece is cross-posted from A Dash of Insight with permission.