Try to predict the market… and this may happen to you
Wishing you a long life, we don't want anything bad to happen to you Sir
Poor Dennis Gartman… I feel for him. He's been constantly picked on by online blogs and in Twitter because he has been having a long streak of missed market predictions (a rather long one?), in the ultimate case of financial cyber-bulling.
Some people have even started using him as a "contrarian indicator", whatever he says, do the opposite and profit.
The "directional disease" is a big one. It is when our ego thinks that it knows better than probabilities and thinks a stock or an asset will move up or down and reach a certain price with probability of 100%. Nobody can predict the future, at least consistently.
It is also possible that some big investment/trading firms like Goldman Sachs and JPMorgan sometimes use their brand name in order to make predictions.
Not necessarily to be right and provide useful advice, but rather because they have painted themselves in a corner regarding a position on a stock or an asset, and the best way to get out is to turn on the megaphone, go on Bloomberg and CNBC, and let the investment herd take them out of their troublesome situation.
So why is it a great thing that no one can consistently make correct bets on the future?
Because that means that there's opportunity to make money from those who are trying to do so.
Implied volatility is a measure of how much the market expects the price of a stock to move. It is calculated from option prices, that's why the term "implied" in the name. The bigger the expectancy of a move there is or the greater the importance of an event, the higher options prices will be and in consequence Implied Volatility as well.
How can we take advantage of this consistent imbalance?
First - by recognizing it. Implied volatility in a stock can rise for many reasons but nevertheless, in order to be significant, it has to be much higher or about the highest levels than it has been during the past year.
How can we check for it?
By looking at IV Rank. It is a measure of comparison from Zero to 100% being 100% the highest it has been during the past year.
Second - by selling or shorting this volatility. Why?
Two of the most important "Tastytrade Tenets" are:
1) "Implied volatility is overstated" -in particular to itself: its historical values- 80% of the time.
2) "Implied volatility is mean reverting"
These two principles are really one and indivisible. Overstated means that its exaggerated. People have fear of the unknown and due to a survival mechanism, inherent to human nature, and in order to protect from it they are willing to spend money.
The psychological aspect of this is related that negative thoughts are more likely to "stick" in our mind rather than the positive ones. A primitive survival mechanism that evolution gave us in order to have the best chances of staying alive.
And mean reverting means that at some given point in time, the uncertainty stops because new information comes in that completes the picture and fear subsides.
It's like when you are at home at night, it's very dark and hear strange noises and don't know what's going on. Your mind starts creating a million negative thoughts to prepare you for the worst, you think it could be a burglar and grab a bat just in case.
Then, you look outside the window and see some stray cat having fun with the garbage cans.
You were fearful, you made an effort to protect yourself and then you had new information that shed a light of reality on your thoughts. The fear was gone once you knew the truth.
And this relates a lot to education as investors and traders. Industry professionals overcomplicate things, create myths and fears in order to make us think we can't manage our own money efficiently and profitably, that we have to hand it over to "experts" because they know better.
Fear is a great strategy to make money.
But with science and statistical studies, that provide the best PROVEN practices and principles, with a mechanical approach to execution, we can stop those fears dead in their tracks.
Ignorance is expensive and painful, and knowledge is profitable and reassuring. You can bet your life on it.
Originally published in: www.mytraderjourney.com