“One of the things I most want to emphasize is how essential it is that one’s investment approach be intuitive and adaptive rather than be fixed and mechanistic.” –Howard Marks
One huge trend I’ve noticed in financial social media lately is the use of statistics and market history to project future price movements. This is really cool stuff, actually, and it’s data that most investors haven’t had access to at all until now.
What I’m specifically referring to is all the traders out there, and there are plenty of them now, that see the market do x and then pull up all the times it’s done x in the past to see what it’s meant going forward.
This type of quantitative analysis is great in that it helps you become more objective and less emotional with your trading or investing.
But it looks to me like investors are beginning to rely on it a bit to heavily. It’s use is becoming a bit too “mechanistic,” as Howard Marks put it in his book, The Most Important Thing.
A great example of how traders can be overly reliant on this sort of thing was the Russell 2000 death cross a few weeks ago. Last month the index’s 50-day moving average was close to crossing below its 200-day moving average. This is known as the death cross because it sometimes signals that the overall trend is changing from bullish to bearish.
Traders ran all the previous times in history these moving averages crossed down and found that, historically, it has actually been a more bullish development than a bearish one. In fact, it got so popular to poo-poo the “death cross” that even CNBC and Jim Cramer ran with it calling it a “bull signal.”
The index has lost nearly 10% in the 3 weeks since then.
“To achieve superior investment results, you have to hold nonconsensus views… and they have to be accurate. That’s not easy.” -Howard Marks
Once the crowd takes up an idea it’s just probably not going work out. Once everyone viewed the Russell 2000 death cross as a buy signal – and probably positioned themselves that way, who was left to buy and provide the incremental demand to make the signal work out? Nobody.
Right now traders are looking at all kinds of bullish signals for stocks based on the “history” of the past two years. And as much as I appreciate the value of a quantitative approach, I worry that this type of analysis may have become too consensus and “mechanistic” for my liking.