Wednesday, November 11, 2009

Rational v. Rationale

Reader, Bryan, writes to ask me if I still use Marty Chenard's wonderful service: I had to answer no. And in answering no, I was inspired to write a post on it. I'll try to be quick in getting to the point--but sometimes that is a struggle--as there have been some other mosaic thoughts that I wanted to cement together.

Technicals v. Fundamentals: Many claim to be traders on technicals, but are consistently overlaying fundamental arguments to persuade or dissuade a decision about entering/exiting a position. Ultimately, it is the price of a stock that that makes our accounts go up or down fundamentals notwithstanding, and our opinion about them be damned. Marc Faber's powerful observation that economic reality and the market's perception of economic reality are two different things. Nevertheless, there is much energy when those two worlds collide, and they always do. Readers know that I try to make sense of both. Further, my embracing the disparate time frames of those two time frames, as made a world of difference in my being (ahem!) early in applying my fundamental thesis to the market's current perception. Timing is everything.

Sentiment: I was having lunch with a very good friend...a career banker. We were talking about the market, and he was expressing disbelief that market was moving up. He proclaimed: "I'm a contrarian!" I looked at him steadily and simply stated, "But you didn't sell when the market froth was at its highest." Personally, I have trouble with sentiment indicators. What people say about their feelings and what they do with their money may be vastly different. They may think that the invisible hand of the market is on the toilet knob ready to flush and are 100% invested--with great trepidation. I've not done any research to validate that opinion, so I'll just throw it out at face value.

Are you tapping your toe now, wishing me to get on with it? As human beings, we are endowed with an amazing creative ability. Whatever we do not fully understand or comprehend our need for a construct in which to operate ASSURES that we will create a mental model to make sense of it all. If the market is going down, the market is going up, the market is going sideways.....we have all manner of media that is going to impose upon us a construct--a model--that gives meaning to the move. And, we know, because we pay attention to these things, that there are very smart people who presumably are observing the same thing, but come up with conflicting opinions about it. I would say that you want to embrace a reason for it too. So is that endowed creativity a blessing or a curse in navigating the markets? I'd say both...but the reasons are for another time and are certainly subjective.

Now getting back to Marty.....Marty has a very rigorous methodology where he is taking objective, observable points and using those to assess risk. It is rational--and from those rational observations he is assessing risk in the market. He also tracks institutional money flows. Money = liquidity = direction = markets rising when increased = markets rising when decreased. Pretty darn simple. But when the rational does not = our rationale, then we have a tendency to disbelieve the rational.

Why did I stop subscribing? Simple...Marty's objective observations--his rational--was not lining up with my rationale. My rationale was simply that we would have a bounce and roll over as I did not believe that we had a true bottom. Why did I believe this? Because the market never failed to go up on good news. I wanted to see the market playing possum for a respectful amount of time--and meet any good news with phlegmatic apathy. It did not comply. Ulitmately, the train left the station without me!

I'm in good company, to be sure. Therein lies the other are always going to find terrific, exciting, intelligent compatriots that subscribe to your point of view. History is replete with wrongheadedness embraced by many.

So I ask you, how do YOU know if you are being rational or if you are engaging in rationale that is either prompting you to action or preventing you from action? How would I answer that question? I'm working on that, but I can tell you this....I'm going to get my label maker and print out a strip and put it on my monitor: Raional v. Rationale. Awareness is always the first step toward change.

P. S. After hitting publish, I re-subscribed to Marty's excellent service.


Douala said...

+1 Leisa. Loved today's post! Also, what a great statement by Faber.

"Marc Faber's powerful observation that economic reality and the market's perception of economic reality are two different things."

Unfortunately I had to learn it the hard way.

Glenn_in_MA said...

Per usual, a terrific thought-provoking post.

Biffermas said...

Confirmation bias in trading plagues presumably everybody. With so many source of information, people can find "proof" of every conceivable position in investing they hold. It's impossible to purge this, but like you said, "Awareness is always the first step towards change". Complete neutrality in investment opinion is a direction, not a destination.

Thanks, Leisa!

Leisa said...

D--I held MF's observation fairly firmly in hand until the last couple of weeks. (Ouch!)

B--Unless we get lobotomies (who would want that?), then neutrality will be ephemeral. I think that process + discipline are the amulets against our emotions. In fact, I see a part II.

Biffermas said...

I agree.

Leisa said...

Gang: Thanks for the nice comments!

Anonymous said...

I will take a look at that for you and see what I think.


Anonymous said...

Methinks we need to watch the RU2000 and EFA here. Look divergent and setting up the majors for a possible double top. Secondaries look especially weak.


GGM said...

I to trade best when my understanding of why something is happening. The only valid reason I find for the market going up is Fed liquidity period. This has been a hard year to trade, but I've made a lot of progress in doing so. I know longer care why or for how long. My approach is biased short anticipating an end to market nonsense. But how does on survive when we seem to rip long so often?

My approach is load up short on charts that support that view, then compute a hedge based on gain/$50/ES point move. Currently my shorts offset 2.5 ES contracts long. Using pivot points and volume by price histograms I plan for the likely reversal points. I plan to set limit orders to by ES at these sell off points, and ride the upward bounces to resistance points.

The key concept to focus on, is well placed trades have your back on the hedge trades. The ES is a wild ride, but if playing it long as a free trade with no downside, it's almost stress free. So normally I might play one ES long, but this approach I can play 4 ES long with risk on only 1.5 ES.

Just have a plan. For instance say we sell off 10 ES points. , & I expect a reversal. At that point my core holdings are up $1250. I go long 4 ES contracts, but we continue to fall. What's my real risk? My core position covers 2.5 ES, and I'm up $1250 when I hedged. That means the market has to fall 16 more points before I'm in a loss overall. My approach is to figure that after a 10 point move against my hedge, I close the hedge, & exit my core positions, walk away and put on another trade a different day, still leaving about $300 profit.

The key is to have each contingency decided ahead of time, then there is no fear, just trade the plan. As to the hedge scale out at key levels, & scalp in the direction of the hedge on pull backs.

One can make more on the hedge then the core trade. The focus needs to be making money. & if all of it is made on the hedge and the core position stops out, so what.

Anyway it's what I strive to do. - G

Anonymous said...


If the approach works for you, use it. Trading is about having confidence in your approach.

Your approach would work well enough in this market. Trade what works. I can point to periods recently that your approach would have led to nothing but losses. I hope you can too and can tell when to abandon such a strategy.


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