Market Myth #1 - Why

This is the first in what will hopefully be a series of posts dispelling common market myths that only reduce your ability to succeed at trading.

The first I want to talk about is the common mistake of trying to assign a “why” to every market move. Let me start first with an example. Everyone remembers the huge down day we had on 2/28 which was preceded by a large down move in the Chinese market. After that day, the financial press as well as many traders quickly determined that the China sell off was the “why” the Dow lost ~500 points. Fast forward to yesterday when China experienced a similar sell off overnight, the US markets gapped down a sizeable amount and any trader who beleived that a China sell-off equaled huge down day in the US markets could not wait to get short. Of course the large amount of traders leaning to the short side most likely contributed to the nice upday the US markets ended up with. Why did this happen? Why did a huge selloff in China in Feb lead the Dow’s biggest loss in years while the same thing yesterday led to record highs?

The answer is (and this is the hardest part) that there is not an answer. The market is not an equation to be solved, you can not simply take the same inputs multiple times and expect the same results. Remember the market is made up of numerous participants, all of which have have different emotions, positions and goals every single day. This is one reason why the economic reports are so hard to trade ahead of, even if you knew what the # was going to be, attempting to predict the response is extremely difficult since everything is based on perception of expectations. Therefore you end up in a “the market is expecting a good #, even though the # is good, is it good enough to overcome the expecations and did the participants who anticipated a good number already take their positions, thus driving up prices prior to entry, etc”. It becomes a very circular logic trail which I’m not capable of decoding.

The same applies for any indicator or market internal. Many people view breadth or volume as predictive. It’s not, it’s just a measurement of where things are at a specific time. Don’t let people tell you that a decent size up or down day did not matter because breadth or volume did not confirm. All the matters is that the market is moving in one direction or the other and your positions are either gaining or losing money. If I’m long equities and my portfolio is down 1% for the day, it’s of little consolation that it was “low volume” or “non-confirming breadth”. Remember, when you sell a position at a profit and deposit the money into your bank, the dollars are not tagged with a “these $$$ were made on a low volume rally” post-it that reduces their value.

Making money is the goal, not trying to predict the future. Once you stop worrying about why things are happening and just focus on what is happening, you will find you have much less of a bias and are in a much better position to react to unusual events. As I often tell people when they ask me “how do you think the market will do the rest of the year?”, I can see the Dow ending the year at 15,000+ as well as the ending at < 10,000. There are scenarios that could easily lead to either of those of numerous others. What’s important is not where I think the market will go or why, but that I am positioned to trade my account profitably in any of those scenarios.

- John