Why Financial markets are counter-intuitive?

December 11, 2017

A few days ago at a conference I heard the following sentence: "Drink food and eat water"; initially I thought that the rapporteur was disillusioned, but in reality this sentence has a far-reaching meaning, it means that we have to chew the food very well until we make it liquid and for water instead we have to keep it in our mouths for a long time before we can swallow it.

This sentence is counter-intuitive, which means that the right way to behave is the opposite of what the original belief has taught us since we were small.

 

Why are the financial markets counter-intuitive? Simple, have you ever met even one person who invests in stock exchanges to lose money? I never have, however, I have met many people who have lost money on the stock exchange. This means that even though people think they are acting in the right way, in reality, they make some errors that lead them to make mistakes; if the markets were predictable and intuitive, everyone would gain from investing in them, but by being counter-intuitive people fall into their own trap and therefore behave in the wrong way.

It happened in 2009 when the markets were at their lowest in terms of indices, but it often also happens with respect to individual stocks or in subperiods.

 

This is one of the main reasons why I don't believe in clichés such as "sell in May and go away" or sell in May to go on holiday, a motto that often worked, but that if by chance you try to apply it before time the opposite happens and you can't then blame the famous "law of Murphy" that punctually strikes when you do such operations.

 

Murphy has simply realized that people need a lot of confirmations before acting and therefore tend to move when it becomes very unlike statistically that the phenomena will continue to occur. Let me explain better, if you observe that in the last 10 years selling in May and buying again in October would have been profitable and you decide to sell in May, you are actually exposing yourself to the possibility of losing, because there is no or almost no foundation on this market rule and so if you decide to sell in May and then in October you are forced to buy higher, you can not blame Murphy, but your statistical misinterpretation of the market phenomena.

In saying this I am obviously exposing myself to the opposite probability, that this year to sell in May and buy back October will be the best operation of the century, but patience, willingly risking the reputation for the statistical culture to grow and no more listening to those kinds of speeches that you should sell on the second Monday of the month and buy back the on third Wednesday. (it is, of course, just an example).

 

Finance is one of the only activities where you can rewind the tape as many times as you want and you can simulate what would have happened if.... (But in sport, for example, it is not possible).

This practice leads us to always find past solutions that could have gone well, but which obviously could not have been seen beforehand and therefore ex-post are all phenomena, but we have to take decisions ex-ante in conditions of uncertainty and this is the main reason why models on average and variance with ex-post analysis are of little use.

DB

 

 

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December 11, 2017

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