I honestly do not know when or where I first heard of James Montier but believe it was a turning point in my investing and money management. Behavioral Finance / Investing is a relative newcomer to the world of investing, or at least the identification and writing about it. The human frailties have always been here, we just didn’t have a word to describe them. Plus, I have more than once mentioned James Montier’s latest book, “The Little Book of Behavioral Investing” in articles with the comment that you MUST read it and then plan on reading it once a year. I first wrote about it in an article entitled Know Thyself. This article will be about a document he wrote in 2005 entitled Seven Sins of Fund Management.
Watching the evening news can give you a misleading and often wrong perspective on the stock market. Most commentators mention whether the Dow Jones Industrial Average was up or down and by how much, and that is just about the complete financial report, even though the Dow Jones’ 30 large blue-chip stocks do not give a good representation of the overall stock market. It is a misguided focus.
I have written often about market internals or market breadth. In fact, there was a whole series of articles as I was updating my “The Complete Guide to Market Breadth Indicators” book. The articles began with CGMBI; there were 10 of them, all back near the beginning of my article list. See links at end of this article. What you may not know is that every breadth indicator in the book is now part of StockCharts.com’s Symbol Catalog. They all begin with !BI followed by two letters identifying the exchange they are from (NY for New York, NA for Nasdaq, and TO for Toronto). More on this sales job at the end of this article.
Oh no! He is losing it! I have stated a few times that the well seems to be running low; this article might confirm that. Here is an attempt to turn basic aerodynamics into an investment process.
CL is the coefficient of Lift
p is the density of air
V is the freestream velocity
A is the surface area of the lifting surface
L is the life force produced
Why do investors / traders like predictions? The prediction industry is not just Wall Street, there are business forecasting companies, economic analysis and forecasting, sales forecasting, on and on. However, Wall Street seems to have the least talent of the bunch. Here are some reasons I think investors / traders like predictions:
I have written about how inept the news is when it comes to the financial and stock markets before. Since I am retired I am trying to wean myself from the news. It isn’t easy as I’ve been a news junky for decades. In this article, I’m going to stick to the news generated by the financial press even though I think news today has become unreliable and downright embarrassing. I was watching a financial news show the other morning (Monday, Aug. 28) where the anchor speaks with a British accent. He is quite good at his job but he is constantly trying to relate the most recent “breaking” news with what is happening with the market. This morning, a couple of days after the hurricane Harvey struck Houston, he just cannot understand why the market opened to the upside. He hints that the market is not paying attention. It is he, who is not paying attention. There is only one fact that answers his question and that is simply that there was more buying enthusiasm than selling enthusiasm. Any other answer is just a guess. We do not know why investors and traders are doing what they are doing. There is no way to measure it, and if you cannot measure it, you cannot rely on it.
Did you hear about the six-foot tall Texan that drowned while wading across a stream that averaged only 3 feet deep? The “World of Finance” is fraught with misleading information. The use of average is one that needs a discussion.
Here is the scenario: You believe we are near a top in the market. I won’t bother to discuss what makes you think that, but if you do, then here is a sampling of things to consider. I was originally going to do this in an enumerated list, but decided my rambling would be better.
I would imagine there are many readers that are fairly new to market analysis and in particular, technical analysis. We have had 10 bear markets in the S&P 500 Index since 12/30/1927 and 15 bear markets in the Dow Jones Industrial Average since 2/17/1885. A bear market is defined as a drop of over 20% from the previous high. Not sure who said or claimed this, but I’m accepting it. Our last bear market lasted from 10/9/2007 until 3/9/2009 (top to bottom). If you have not been an investor or trader during a bear market (last 8+ years), then you have missed one of life’s educational events. Let me introduce a bear market to you using the Japanese Nikkei Average.
I will attempt to show that high sigma is a much more frequent event than modern finance thinks it is. A few examples using the Dow Industrials back to 1885 on a daily basis are shown. Each begins with determining a look-back period to determine the average daily return and the standard deviation, and then a look-forward period is determined to see if the look-back data continues into the look-forward data. Figure A is an attempt to help visualize this process. A look-back period is determined (in-sample data) and a look-forward period is also determined (out-of-sample data). The look-back period is used to determine the average daily return and the standard deviation of returns. From that data, a range of three sigma about the mean is determined. Then in the look-forward data, the number of daily returns outside the +/- three sigma band are tallied with the total being displaying as a plot; any point on the plot represents the data used in the look-back and the look-forward periods.