Draw Enough Lines

LB showed me an email she received the other day that contained a chart of the All Ords purporting to show that the markets long term support had held. The only problem with this chart was that it had more lines on it than the ancient carvings at Nazca.  This is the default setting of many in the markets – draw enough lines and then try and either divine some form of analysis from it or alternatively go I told you so. The I told you so seems to be a default setting of Elliot wave technicians who cant seem to make up their mind as to what stage the market is in but are seemingly 100% correct when looking in their rear view mirror.

Any way the piece LB should me reminded me of something I wrote many years ago that dealt with a similar topic.

I have a new trading system and judging by the interest shown in such things at the last Investment Expo it is going to be a corker. You see I can predict the future using the ancient secrets locked within the mysteries of Gilligans Island.  Yep the Skipper and his little buddy left us a vast treasure trove of extraordinary computational techniques with which we can predict the market for generations in advance.

Now stay with me because this gets rather complicated but it is worth it.

Gilligan and company were finally rescued in an episode that aired on 14/10/78 now if I reverse this date I get 871014 – that’s right the 14^th of October 1987 the day the 1987 crash really accelerated. The clue to reversing the dates comes from the name of their boat – the SS Minnow you see if you reverse the letters you get winnow, which means to get rid of something undesirable. Share prices were undesirable in 1987 so we had to winnow them out.

This is not all the series ran for three years each year has 12 months or 52 weeks. If multiply these out I get 1872 which is only 31 points off the low the Dow hit following the crash. In addition to this there are further secrets hidden within the show. If I take the average number of coconut cream pies that Mary-Anne made per episode (1.70) and multiply that by the number of years the show ran for I get 5.1 years, which is the exact amount of time the 1990’s bull market ran for in the US.

Not only that but they made 98 episodes and Alan Hale JR’s father Alan Hale starred as Errol Flynn’s sidekick in several films in the 1930’s. So if we multiply 98 episodes by the number of letters in Errol Flynn’s name we get 980 which is only 15 points off predicting the low for the NASDAQ after the 2000 crash.

However there is more, recent events have also been predicted. For example if I take the square root of the average number of coconut cream pies made each episode and then add those two figures together and multiply them by the year the show finished I get 1.30 x 1.70 x 1967 = 4347. This is only 7% off the actual peak in the ASX 200 in October – a remarkable feat of precision for a prediction made 38 years ago.

What is more remarkable is that such a seemingly innocuous show could predict so many other events. For example Alan Hale JR died at the age of 72 and it had been 72 years since South Melbourne/Sydney Swans had won a premiership.

Sound stupid, well it is but this sort of galactic idiocy is common in financial markets with everything from people being able to predict the future using everything from astrology to the number of wrinkles on Tutankhamun’s bum to the bizarre fact that shares have birthdays that they remember. And I am not making any of these up.

All I have done is strung together a few random facts and squeezed them to fit a series of absurd observations. As interesting as this may seem it does raise the problem of why do people believe such dopey assertions. The first reason is the blindingly obvious one that some people are not intellectually equipped to deal with complex scenario’s. We all have moments of denseness but for some these moments are prolonged.

However this does not account for the population of seemingly intelligent individuals who subscribe to such loony ideas – there must be something deeper at play. Dimness in the face of evidence to the contrary has become a fertile filed in academic circles with the likes of Gene Ostrow and Robert Sternberg trying to figure out why otherwise intelligent people believe and do stupid things. The findings are interesting in that intelligence does not seem to generate prophylactic protection against believing stupid things or behaving in a stupid manner. Such news is depressing for traders since we are all prone to bouts stupidity.

Professor Michael Shermer formerly of California State University, the founding author of Skeptic Magazine and the author of “Why Smart People Believe Weird Things” offers something of an insight into what initially seems to be extremely irrational behaviour. His first insight is that smart people believe in things because they are skilled at defending beliefs they have arrived at for non-smart reasons.

So we have a situation where someone may believe in astrology because they read their horoscope one day and it coincided with what might have been happening to them at that point in time – they therefore believe in astrology simply because of chance. Due to our poor innate understanding of the role of chance in our lives and the likelihood of coincidence this person now has a full blown belief in the power of the stars to guide their ever move.

They will then seek to defend this believe with their intelligence. Traders do a similar things, think of the number of times you have bought a stock for whatever reason perhaps something as silly as it was mentioned in Shares magazine. You then seek out evidence that selectively suits your point of view and defends your ego from the problem that your initial decision may have been ill advised. Ego defensiveness is a killer among traders since it prompts a complete overriding of prudent money management.

If ever you want to have fun with someone who believes in astrology and you have a newspaper handy ask them their star sign and then read out their horoscope for a completely different sign. You will be surprised at the affirmations they give off about how accurate it is.

Among people anecdotes hold greater sway than evidence, this seems to be because humans are verbal in their communication. We like stories as opposed to cold hard facts that we may not be able to digest. As such we place much greater weight on tall tales, so if I tell enough people that I can predict the markets using tea leaves I will generate a following that are willing to pay for my predictions. Bold statements do not make claims true. However because of our verbal tradition and our tendency to believe in figures that appear to be authoritative often despite evidence to the contrary.

The interesting point that Shermer makes is that intelligence is often not multi faceted – polymaths or people who are good at a multitude of disparate tasks are quite rare. Just because you are smart in one field doesn’t mean you are smart in another. Which means it is quite possible for someone who is skilled at a given profession to believe dopey things about markets.

So the question for the trader becomes one of how do we deal with the tendency of our brain to lead us up the garden path with surprising regularity. Without sounding cynical for many there is no hope. I could raise a multitude of reasons as to why we cannot predict the future from the common sense to the quantum but for many, this will fall on deaf ears because of a need to believe that the uncertainty and randomness of the universe can somehow be controlled.

For the rest of us we face some well known problems such as cognitive dissonance and ego defensiveness which may force us to defend untenable positions. I don’t think there is any trick to overcoming these issues other than preparation, rehearsal and review. The number of traders I see entering markets without a plan or any idea is staggering – they simply lack preparation. In addition to this there is no practice of skills either through back testing or even paper trading as such the market and their reaction to it comes as a bit of a shock. Finally there is no critical review of each trade and the behaviours that accompanied it. Trading is a difficult endevour and requires constant review to improve, you need to work out why you did things in a certain way. A trading journal is therefore a must for all aspiring traders.