The Nicholas Cage film Next is about a guy who can see two minutes into the future. He works as a Las Vegas magician and makes extra money quietly at the blackjack table.

 

As traders and investors, we would love to be able to see around the corner of time, especially during volatile periods. Since we can’t, when money is at risk, we tend to become fortune tellers and use our intuition to help inform our expectations.

 

Nobel Prize winner and Behavioral Finance professor Daniel Kahneman studied this behavior and noted that when people make financial judgments under conditions of uncertainty, we do three things automatically:

 

1) Look for a Pattern;

2) Project an Outcome; and

3) Qualify the Outcome with an estimate of Degree (depth, duration, distance, etc.)

 

You will observe all three when listening to media pundits: ‘this is the pattern in the market, this is the direction we are heading, and this is the degree or target.’ But according to the more skeptical Freudian view, our fixation on financial prediction may be little more than a means of collective anxiety reduction.

 

FLIGHT TO OPINION
If Freud is right, it’s not simply that markets hate uncertainty; everyone hates uncertainty because living under financial uncertainty is stressful. So we flee into opinion; a flight to semi-certainty. We do this all the time.

 

In the heat of the moment, we make a snap judgment: “Up” “Down” “Sideways.” This opinion arises from our intuition, our guessing function. And when it comes to financial guesses, we usually dress them up so they sound, well, ‘educated.’ And that’s where technical analysis comes in, as it can be used to support any opinion (bullish or bearish.)

 

But in truth, the market is a perverse Mistress. She defies not only prediction, but explanation. We can never know the answer to questions starting with “Why?”

 

  • “Why did it go up?”
  • “Why did it go down?”
  • “Why did it go down and then up?”

 

These are simply the wrong questions to ask.

 

EXPECT THE BLACK SWAN
Nassim ‘Black Swan’ Taleb criticized traditional economists for using an outdated statistical model to measure the probability of real world market-moving events. His thesis: prepare for the unexpected and the unusual, it’s a lot more probable than you have been led to believe.

 

If we can’t know why, we can at least be better prepared for any what: up, down or sideways. If you can see beyond your opinion and recognize what’s actually happening, then all you need is the discipline to act on it.

 

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