I’m fascinated by how people think. And why they think what they do.
In many cases, the thinking is erroneous. That is, it is predicated on facts and ideas that simply don’t make sense when you put them to the test.
Regardless, people need to construct reasons for their behaviour. They often do this without thinking. That’s because it comes from the subconscious. We all have a subconscious narrative that drives our day-to-day decision making. The conscious reasons often come in hindsight.
Thinking about the way you think is crucial when it comes to handling your own money. It’s your thinking that will get you into trouble, not a profit warning from a stock you hold or Janet Yellen making this or that decision.
As W.D. Gann wrote in his classic book, The Truth of the Stock Tape:
‘The stock market does not beat you. You beat yourself by following your own weaknesses, by listening to the man who knows less then you know, by reading the newspapers, following the gossip of the street, all of which is put out to influence you in the wrong direction.’
The book was first published in 1923. It just goes to show you, some things never change.
The reason why I bring this up is that I have received a few emails on the back of the recent stock market rally. These emails suggest that some people are experiencing a bout of ‘cognitive dissonance’.
Wikipedia defines the term as follows (with my emphasis):
‘The occurrence of cognitive dissonance is a consequence of a person’s performing an action that contradicts personal beliefs, ideals, and values; and also occurs when confronted with new information that contradicts said beliefs, ideals, and values’
If you’re bearish on the stock market, the past week or two may have been uncomfortable for you.
But here’s the thing, it needn’t be.
The mistake that most amateur investors make is believing that the market should do this or that. And then when it doesn’t, they scramble to protect their point of view, rather than their capital.
I know, because I used to make the same mistakes.
But now, my life is much easier by simply knowing that I don’t know. I deal in probabilities, rather than certainties.
When it comes to the stock market, it has been my view all year that probability favoured stocks moving higher. That wasn’t my hope or wish, it was just the conclusion I drew from looking at the facts.
And by looking at the charts. The ASX 200 and most commodity prices were in emerging upward trends at the end of 2016. Probability favours a trend continuing.
Let’s have a look at the ASX 200 at the end of last year. As you can see, it finished the year strongly. Stocks were clearly trending higher.
Continuing to be bearish at this point is a low probability play. It’s simply a case of stubbornness and egotistical thinking. That is, ‘I know better than the market,’ or, ‘I need to keep my narrative, not my capital, intact.’
Rarely do you, or anyone else, know better than the market. Only a handful of top pros consistently beat it. And they have trained most of their adult life to do so.
The best philosophy is to be neither bullish, nor bearish. Rather, you should simply go with the flow. And be willing to change your mind — and your portfolio — when the flow changes.
While the Aussie market looked strong at the end of 2016, you can hardly argue that this year has been a great one for the market. It’s spent most of its time going sideways, thanks largely to decent underperformance by the banking sector.
But again, such an outcome was not an unreasonable one to think about if you knew how to read the charts. This is what I wrote to subscribers of Crisis & Opportunity in a 4 January update:
‘This market looks and feels like it is heading higher. The key test will come at 6000 points. This was the resistance level from the early 2015 peak. If the market really is bullish, you could see the index head straight to 6000 before putting in a decent correction.
‘That’s about as much of a prediction as I’ll make for this year. That is, a rally to 6000, then a good correction, before another rally through that level a few months later.’
As you can see in the chart below. That’s more or less what happened in 2017 (so far). Although the correction and sideways movement lasted longer than I thought it would.
And now, here we are again, approaching 6,000 points; a barrier that the market hasn’t been able to break through for years.
Probability still favours the bull trend. The 2017 correction and consolidation could well be the pause that refreshes.
However, it’s unlikely the Aussie market will go straight through the 6,000 point barrier from here. The slingshot move over the past few weeks is running out of steam. It’s more likely you’ll see some profit taking and a fall to 5,800 points or lower, before the market makes another attempt at new highs.
Whatever the outcome, the message is clear: Don’t be dogmatic. Having a view is fine, but when it flies in the face of the evidence, it makes no sense to hold such a view.
On that note, I’ll finish with another gem from Gann. ‘A wise man changes his mind, a fool never.’
Editor, Crisis & Opportunity