This week I’m visiting New York, and while I have been on the road I have had a lot of time to think. One of the quotes I have given significant thought to lately is a quote by a famous investor and hedge fund manager, Bruce Kovner.
He says:
“A common mistake is to think of the market as a personal nemesis. The market, of course, is totally impersonal; it doesn’t care whether you make money or not. Whenever a trader says, “I wish”, or “I hope”, he is engaging in a destructive way of thinking because it takes attention away from the diagnostic process.”
While I agree with the second half of Kovner’s statement, I do not necessarily agree with the first half.
Bruce talks about what I would call ‘wishful thinking investing’ when your investment process is an idealized future that you have in mind (i.e. “I hope XYZ happens”, “I wish ___” would happen, etc).
Folks, after nearly twenty years in the industry, I firmly believe that the future is unknowable.
We can have educated guesses.
We can look at probabilities.
Simply though, we don’t know what is going to happen tomorrow.
Utilizing ‘wishful thinking investing’ gives people an illusion of control that is just out of the realm of reality. It causes people to create an entire narrative in their minds – and because they have such a deeply rooted ‘belief’ in that narrative, they defend it, even when the evidence is stacked against them.
These hopes and desires, while well intentioned, should be kept as cocktail party stories, and not evaluated as real-life scenarios and should definitely not be part of your investment process.
Now, looking at the first part of Kovner’s statement, where he refers to the market as a personal nemesis, my argument is that many people do personify the market. You give human names (Dr. Copper, Mr. Market, etc.) and characteristics to the market, securities, assets, etc. That is a good thing because it is a reminder that the market is driven by human emotions, notably fear. We fear missing out (or FOMO) on the way up and fear losing everything on the way down.
The market absolutely is a living, breathing organism that changes and by personifying it, we are reminding ourselves that it is not just simply a series of numbers but we are constantly trying to understand it.
I like evidence based investing and focusing on trends. When looking at price, sentiment, and factual information, you can quantify what people are thinking. In the financial industry, there has been a move to over-reliance on models, which can cause a lot of problems.
Why?
Because models are not reality.
Models are a model of reality.
Any time you use a quantitative model of some sort you are making assumptions about what humans are like and how they will behave, or react, under certain conditions. Making these types of expectations of rational behavior and how humans will process information and react are simply assumptions of human behavior, which can many times be wrong.
Models are not successful all of the time. There are times when the models don’t work because they don’t jive with what is actually happening in the world.
Gathering evidence is important, but remembering that it is imperfect, however, is more important
Dr. Andrew Lowe, at MIT, has done a lot of fantastic work on finance and technical analysis and speaks about the physics envy of finance. We want to have these immutable laws and specific rules, that are unchangeable that describe the financial market. Yet they just continue to fail. They are models, not reality.
My guidance to you is to focus on the evidence. Remember that the models are not perfect, and the markets are driven by human fear.
RR#6,
Dave
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. Please see the Disclaimer page for full details.