Trading, Fast And Slow

Summary

• The uptick in volatility is mostly a result of those trading "fast."
• Even small pieces of news can create an exaggerated market response.
• Investors who understand the dynamics, can "think slow" and grab opportunities.

In Daniel Kahneman’s excellent book, Thinking, Fast and Slow, he investigates two systems of thought. The first is quick and automatic. The second, more focused on complex issues. Both employ heuristics, but in different ways. Both involve non-rational thinking.

While I am borrowing the title and the general approach, it is not a perfect analogy. So much volatility driven by minor snippets of news. It is time to think about why.

Market Heuristics

The human desire for an explanation for everything drives social media. There must be a reason! The PBS NewsHour show today attributed the stock rebound to economic news. Forget that such news was reported either before the opening or in the first thirty minutes of trading. Other sources assigned different explanations, but none were very credible.

In the last two weeks, we have seen multiple examples of “trading fast.” Here is how it works.

1. There is a news-driven stimulus. These are all actual examples.
   1. There is a raid on the office of the President’s lawyer;
   2. One semiconductor company provides a clouded outlook;
   3. A tweet or an overnight speech hints at a change in trade talks;
   4. A news conference suggests higher (or lower) tensions with Iran or Russia.
2. Traders react. Most people do not understand the basic trader approach. You often “take a leg” leaning in a direction that seems to capture the mood of the market. If it goes your way, you ride it. If not, you try to scratch it for even or a small loss. Every piece of news has a simple evaluation: bullish or bearish.
3. Algorithms react. The top computer systems have learned the keywords that are associated with market moves. These are even faster than the traders.
4. Technical traders react. The market reaction may send stock prices through levels widely viewed as important support or resistance.
5. ETFs that hold the key stocks plummet. Other companies in that ETF get slammed, even though their fundamentals are essentially unchanged.
6. Financial TV brings in the chartists, who cite the temporary breach of the 200-day moving average, the move of averages into “correction territory”—more than a ten percent decline, and the level of decline possible in a Fibonacci retracement. Take your pick!

The least valuable heuristic treats the market as a war between two sides. This approach offers comments like the following:

• The bears are in control
• The bulls must defend the 2500 line
• The bulls are absent – a buyer’s strike

And many similar statements. This is an entertaining way to (over-)simplify the market. We can all visualize a two-player game. Few can think about the wide variety of groups that are actually represented. Let’s turn to some facts.

The market participants

Those focused on daily news and an excessively frequent review of account statements might make a trade. More importantly:

• The clear majority of investors and managers were doing nothing;
• At the investor level, people were not even aware of the market volatility, at least until the evening news;
• The field was open for System one, short-term thinking.

The events

What is the rational interpretation of key events? This is just a starting point for astute readers.

• China response on tariffs. Pretty mild and not a surprise. It is a routine part of the current negotiation. If anything, the overall prospects for compromise have improved.
• Trump attack on Amazon (AMZN). More of the same.
• Chip stock conference calls – basically good as confirmed by Apple (AAPL).
• Overall earnings reports – new records, despite the few clunkers.

Conclusion

If you try to “trade fast” you are competing with top-flight competition. If you have analyzed stock values, and can ignore the noise, you may find it very profitable to “trade slow.”

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Ian Farbrother]

"The least valuable heuristic treats the market as a war between two sides."

Couldn't agree more !!!

... and "The clear majority of investors and managers were doing nothing;"

Yes - I remain always aware that the short-term moves are always 'on the margin'.

As User25... points out: "ignore the long term charts at your own risk".

I don't get seriously concerned unless long-term weekly charts start to roll over ...

Cheers, Ian

[newfruit]

Reading that book right now... it certainly pays to think slow.

[Arbywon]

Thanks for the reminder Jeff. I know this! I know I know this! Yet, I find it difficult to stand still when those around me are in panic.

[kevinconway]

Thanks Jeff. I am a behavior based investor. Every stock has it's own way of behaving based on the people who own/trade it...once you have a good understanding you know what is going to happen, up and down. Takes at least a year of watching a stock, daily, to really understand.

And that is key to making money....events will impact stocks differently...just like people react differently to a set of variables.

Since I am now 70 I have mostly stopped doing this...RISK MANAGEMENT...with a focus on WEALTH PRESERVATION. It is tempting to get back into the game, can be a lot of fun but, in a market like this you have to be very careful.

[User 25572753]

Spot on article Jeff ! I am mostly technical long term, strictly technical short term.
Fundy's confuse me (and many others ) so I rely on my beloved charts. In my opinion,
ignore the long term charts at your own risk. They have kept me out of a heap of trouble
at times. I could never get riding stocks down because one "thinks" the fundamentals are good. Look at the reit market..those charts broke down a long time ago, yet many keep buying, keep holding thru 20-50% drawdowns being happy with the dividends--I cannot do that, just not my style.

"Trading" the markets is not an easy task, look at the competition, as you noted. With that said,
it could produce some nice income if done properly. Personally, I have 2 accounts, 1 for trading
and one for the longer term. Never mix em, and I guess I think slow and fast--lol--.
Best to all no matter your style.

[sarge101abn]

You are right on target Jeff, thanks for this informative article, it reinforces my own thinking. I’ve been in the market since 1984 and during my early years I fell into the drama traps, listening to the talking heads spreading doom and gloom and thinking they knew something I didn’t and reacting accordingly. I do my own research and rely mostly on various print media and tune out the television.

[luckymonkey]

I finished the book yesterday, coincidentally. A tougher read than I expected. Highly recommend The Undoing Project if you have not already. Thanks for the great article, as usual. Pretty soon 2009 will be removed from the E in CAPE and the perpetual bears will have an even harder time justifying their outlook. The short termism news, however, will never stop.