Many investors get stunned when the economy says one thing and the markets do another. Recently, I hear more retail investors saying, “This rally makes no sense. Unemployment is horrible and getting worse. The market is too crazy for me right now.”
I called upon my friend and fellow Minyanville Professor Smita Sadana to offer some wisdom. Sadana is one of the best pros on Wall Street, and this is what she had to say about this important issue:
Damien Hoffman: Smita, what advice do you have for investors or traders who can’t believe their eyes as the rally continues in the face of weak economic data?
Smita Sadana: Damien, this is an excellent question and thanks for asking for my opinion on this important matter. The reality is that your question transcends the current market and is true for most market participants in many market timeframes.
Here’re my thoughts on how to deal with the market as it is, and not as they would like the market to be.
1. Keep an open mind.
The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still function.
— F. Scott Fitzgerald
Don’t be wedded to any thought process, even if it appears intellectually correct. I’ve written about this extremely critical issue at Minyanville (See Why Investors Should Keep Enemies Close).
If our bias is bullish, we’ll keep flicking through channels until we find someone who will tell us what we want to hear — that the market is going much higher and it’s advisable to put all your money in the market.
If we have a bearish bent, we’ll scout through websites and bookmark those that enforce our already bearish beliefs and back it with evidence that we like. Even if dissenting thoughts crop up, we let them gather dust and take solace in the factual data that supports our original thesis.
I often advocate that investors stroll out of their comfort zones and add a few dissenters to their trusted friends via websites that offer opposing views. (You don’t have to swing the pendulum all the way). Even if the opposing views are aggravating to listen to and can turn out to be wrong, they often add depth to our perspective since we have to defend our original views.
Dissenters can give us the greatest gift of all — an open mind, which is the prerequisite for a flexible approach toward investing.
2. Don’t confuse time frames.
There are many ways of discerning a trend. In Bull Market Timer, for instance, we use an intermediate-term trend to modulate exposure to the market and manage portfolio-allocation based on technical assessment of the intermediate trend.
One should leave economists and market gurus to figure out what the primary/long-term trend is. Long-term factors can take years to play out; I often say long-term is made up of several short terms strung together.
Consider long-term to be like a map — you need to periodically refer to it while driving, but it might not be the best actionable guide. In the short-term, the road conditions, the traffic, and the weather play a greater role in ensuring a safe drive than the map.
So, be mindful of the long-term, but know that long-term might not necessarily sync with short-term investing and trading decisions.
3. Follow sound money-management practices.
We all like to hope that a trade will succeed — and a stop is a piece of reality that prevents traders from hanging on to empty hope.
— Alexander Elder
Always have stops in place. Unless one has access to tomorrow’s financial news today, mistakes are expected. So, it is okay to be wrong; it’s not okay to stay wrong! Having well-defined and steadfastly executed stops forces investors to question their original premise and get out of harms way if that premise is flawed.
Such self-policing is extremely important since, unlike institutional investors, no one is looking out for individual investors.
4. Commit these mistakes to memory.
We must accept finite disappointment, but we must never lose infinite hope.
— Dr. Martin Luther King Jr.
Investors usually rely on the passing of time and continued market action to make them forget. They will soon forget “this bounce beyond disbelief.”
We have seen many such market conditions where stocks went up or down in an extreme manner. Consider Intel (NASDAQ: INTC) and Cisco (NASDAQ: CSCO) down 80% to 90% in 2000-03, Chinese market going up over fivefold in less than two years (2006 to 2008), and then giving back most of that gain. Every time such events happen, investors promise to act “next time” but the nature of the human mind is that the recent market action always assumes more importance since it’s the “now”.
However, investors must find ways to etch these mistakes on their trading psyches. The market always has lessons for us but lessons never really sink in; investors continue to make the same mistakes over and over again.
I often feel that pain shouldn’t be so much that it makes an investor shell-shocked and unable to act, but it also shouldn’t be so little that it doesn’t even register! I find keeping a trading log greatly helps in “opportunity-loss pain-management” (or other forms of mistakes) — that way one can refer to it in the future and not just let time erase the mistake into oblivion.
“That’s what learning is, after all; not whether we lose the game, but how we lose and how we’ve changed because of it and what we take away from it that we never had before, to apply to other games. Losing, in a curious way, is winning.”
— Richard Bach
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