In Bullmarkets Everyone Is A Genius, Not!

``Moreover, life is not long enough;- human nature desires quick results, there is a peculiar zest in making money quickly, and remoter gains are discounted by the average man at a very high rate. The game of professional investment is intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll.”–John Maynard Keynes

I would beg of your indulgence anew because I’d be dealing with issues that would defy the wisdom of the consensus.

For some, such may deemed as blasphemy, but for us, it has been a mission to disseminate our version of the truth or reality as we see it. It’s called prudent investing in our terms.

That’s because we’d like get protected from the worst enemy that any market participant or investor has always been confronted with; that’s no less than ourselves or our inflated egos.

As Friedrich Nietzche, ``But the worst enemy you can encounter will always be you, yourself; you lie in wait for yourself in caves and woods."

Self Attribution Bias: In Bullmarkets Everyone Is A Genius

There’s an aphorism that everybody’s a genius in a bullmarket.

In a sense that would be true, that’s because bullmarkets are basically tolerant or permissive of our mistakes.

Missed the bottom? Sold “low” or too early? Bought “high” or too late? Don’t you worry, markets will eventually redeem our positions! That’s because “High prices will go higher”!

In the same dimension, we have myriad of reasons for taking on positions: corporate or economic fundamental analysis, chart patterns or momentum triggers, recommendations from an expert, a “tip” from an associate or from social circles such as stock forums or parties over an insider info on M&A, joint venture, corporate buy-in, capital infusion or etc…, or simply because a friend said so- they’ll all be proven correct for basically the same principle!

Every trading success builds on our self confidence, even if they are founded from logical mismatches. For instance, conventional fundamental analysis is a long term proposition whereas assessing or weighing on ticker tape price gyrations by typical market participants are very short term in nature-so how does short term price watching square with the long term developments?

Yet with every success comes the attribution of our skills into the performance of our trading positions or our portfolio. A clear manifestation of this would be in social gatherings, where people would bluster about having bought stock ABC at the price X (bottom or near bottom) or sold the same stock at the price Y (top or near top).

Nonetheless, our so called “genius effect” is a common psychological foible known as the Fundamental Attribution Error or the ``cognitive tendency to predominantly over-value dispositional, or personality-based, explanations (i.e., attributions or interpretations) for the observed behaviors of others, thus under-valuing or failing to acknowledge the potentiality of situational attributions or situational explanations for the behavioral motives of others. In other words, people predominantly presume that the actions of others are indicative of the "kind" of person they are, rather than the kind of situations that compels their behavior.” (wikipedia.org)

In market terms, the Fundamental Attribution Error or the Self Attribution Bias is the tendency for people to attribute success to skills and of failures to bad luck or adverse fortune, when the reality is that they have only been responding to situational developments.

Here is a matrix of how the Self Attribution Bias works…

And perceptibly this has been the same reason why during bear markets people from the industry have been in the receiving end of brickbats.

Example, in the US uproar over the executive compensation brouhaha could partly be construed as the receiving end of the attribution bias. [As an aside, the financial industry has been the primary funding conduit of the US real estate bubble as a result of government policies that has vastly skewed their operating incentives see US Home Bubble Cycle: Upside Directly Proportional To Downside. While they are partly to blame as much as those who assumed the risk, the prime culprit would be government policies that fueled such mania. In a gold standard, none of these would have transpired in spite of market irrationality.]

So instead of having to take full responsibility over one’s decisions, in bear markets where decision errors have been glaringly penalized, the attribution errors by the sundry of market participants find an outlet in the blaming of others.

Despite the armies of so-called experts [economists, risk managers, statisticians, actuarial managers, lawyers, accountants, quant modelers etc… for both the buy and sell side institutions] in assessing the risk environment, isn’t it a wonder that most of those who suffered forget that risk ever existed at all?

Now, the consequence has been a barrage of lawsuits.

Profit From Folly

To quote Edwin Lefèvre in behalf of legendary trader Jesse Livermore in the classic Reminiscences of a Stock Operator, ``In a bear market all stocks go down and in a bull market they go up...I speak in a general sense.”

I would add that the phenomenon of blaming of others can be extrapolated as “in a general sense, in the ambiance of bullmarkets, relationships are harmonious and in bearmarkets they turn acrimonious.”

Why? Because as noted above, markets are fundamentally powered by psychology. (see figure 1)

Figure 1: Market Cycle Equals Psychological Shifts

As you can see, the fundamental attribution bias segues into “overconfidence” at the apogee of the every market cycle.

However, such psychological extremes eventually swings like a pendulum as the market transitions towards the opposite end, hence the accompanying psychological frictions in between the cycles.

Let me add that I have personally envisaged some instances of such “relationship disharmony” from this crisis. So this should come naturally or even intuitively for those who understand or have been disciplined on how the market cycle works.

Nevertheless, since markets always operate over the same process, then we should learn how to take advantage of the psychological lapses than fall prey to them.

As Warren Buffett have long admonished, ``Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

Thereby, the underlying goal of any serious investor should be to remain composed or calculably rational over the transitional phases of the market cycles while being cognizant of the progressing dynamics of the risk spectrum and likewise be insouciant to the wild swings of market psychology.

Taking away all that ego oriented stuffs diminishes the oomph of the markets, such a killjoy isn’t it?