Columnist and author Jason Zweig writes in his weekly The Intelligent Investor column that “Much like the choice of whether to invest in stocks at all, rebalancing is a bet about the future“. Forgive me but this should be self-evident – particularly to anyone who reads the WSJ on Saturdays.
The more critical point that Zweig fails to mention and most investors and traders never realize, overlook or forget is that any investment or any trade in any timeframe and based on any analytical method is a bet on ONLY ONE THING – that some other human being is going to be willing to pay a different price than you paid at some moment in the future. Markets are no more and no less.
This may seem self-evident or unimportant to some – after all, we have our fundamentals or our technical analysis and we really only need to bet on the numbers! Really? So how did betting on those things work out in the past 18 months? How did all those hedge funds do using their historical volatilities going into September 2008? Or, those day-traders with fixed stops?
See the numbers – whether from a chart or a projected cash flow – are only a reflection of or proxy for what another human will decide in a given set of circumstances. Take this example, after the run on BSC a year ago this coming week would it have been that hard to imagine that one of the other banks could go down altogether? Would it have been that hard to imagine that Paulson could buckle under the pressure and let someone who had lots of credit-default swaps go BK?
Not if someone paid to predict the markets stopped looking at the numbers, put their feet up on the desk and said … hmmm… let’s think about this purely from human behavior for a moment.
It works in much shorter time frames too – like yesterday afternoon when the ES was trying to make new lows but the speed of the downdraft had slowed and the NQ wasn’t moving down… you see that and you can be sure people are still getting short ES and there is about to be a huge short squeeze. But… if you dont’ think about the other trader’s behavior, your numbers and charts may have said shorting again was a good idea. Especially because your brain defaults into expecting the same result out of the next decision as it got out of the last – another fact that Zweig doesn’t fully articulate even if he did write Your Money & Your Brain.