Bloomberg published an excellent article titled “Your Brain Wasn’t Built to Handle Reality“.
We discussed it a lot between us and our Colleague Principal Consultant in Capital Services Dimitri Paschos made the following, exceedingly interesting comments:
DVKConsultants
Excellent article which addresses the issue of the wrong perception. In Politics, the economy and the financial markets perceptions are very often wrong and probably close to 100% in turning points. In my opinion it happens for at least 3 reasons I know of.
1. Most people try to choose one out of two outcomes, good or bad, buy or sell, black and white. The problem here is not only that more than two choices might exist but some people have the capacity to reason in different dimensions. For example, you think in a different way when you need to solve a trivial problem like paying your insurance today than having a vision about your future.
2. People have the tendency to think in a linear way. The information we have so far should continue. Unfortunately, tomorrow is a very different day than today. Let me give you a concrete example.
Above we have a chart of the Crude Oil Futures Contract. The date is April 31, 2008. The closing price was 113.46. Most if not all, major brokers and economic institutes believed that prices should go up and the main reason prices were going up is that these major players were buying.
Guess what? Look what happened next!!!
In June 2008 prices reached their highest point and closed at $140 per bl and then straight down to $33 in January 2009. The known information before 2008 was completely useless as a forecasting tool.
3. The third issue is that not only people reason in a linear way but they also have a short memory. They still try to forecast the price of crude oil for the next year even if the known information is not relevant.
I can’t tell you how others deal with these problems but I can tell you how I do it:
- Large moves depend on seasonality and crude oil is no exception. Statistically Crude Oil price is stronger in the first 6 months of the year than in the second. Disasters tend to happen in a weak season combined with a weak environment.
- We use precise entry and exit points and we never defy the trend. We are not buyers of anything if the season and the trend move against us. The exception are trades entered for hedging purposes.
- Volatility and risk parameters define the size of the investment. Crude Oil is known for its high volatility.
- Never bet in only one product or Asset Class, invest in at least 4-5 products at the same time.
- Even so, always be prepared for the worst and never invest more money than your stomach can handle.
People are not objective, systems are and I believe that our probabilities of success increase when we trust the method over the opinion.
