Bias

According to Merriam-Webster - an inclination of temperament or outlook ; especially : a personal and sometimes unreasoned judgment

I have always held a bias towards bullishness, I guess it’s just innate in my personality. One of the things that has helped me as a trader and investor is knowing this and adjusting my thinking to account for it.

An interesting thing about bias is how many traders or investors can be described as bulls or bears. When CNBC announced that legendary Uber Bear, Dr. Doom himself, Nuriel Roubini had suddenly become bullish, I was gobsmacked. As I said elsewhere, this is akin to hearing Mother Theresa was seen beating a child.
One of my favorite characters in the world of investing is Dr. Bob Froelich of Deutchebank, you used to see him a lot on CNBC. Bob is an Uber Bull, a genuinely optimistic guy whose life story lends itself to a confidence that things will work out in the long run. If Bob predicted a down market long term I would suspect the real Dr. Froelich had been abducted by aliens and replaced by a golem.

The time when bias is most evident is during bull markets, I believe this is a result of a majority of persons believing things get better over time, sort of a positivism inherent in our cultural zeitgeist. It manifests itself in ways that I find utterly fascinating. Folks come out of the woodwork with delusions of genius because they are bulls in bull markets. They seem to have the zeal of the mob, Wagners “Flight of the Valkyries” their battle hymn. On the other side, during bear markets the predominant attitude of the bears is more righteousness, a sort of “I told you so” smugness. Theirs is the zeal of the prophet of doom, a faith like adherence to the oncoming apocalypse. Their battle hymn is the dirge, the funeral march.

The fact that we are a social species, leads to group think, and thus the two positions are self reinforcing. The bulls gather strength and number until at some point the maximum sustainable number is attained, the last retail straggler comes giddily into the herd as it confidently charges over the precipice. The bears gather their numbers more subtly, lead by the prophets, the masses of war weary victims capitulating to the capricious market. The difference is the majority of this group, rather than taking short positions, expresses their surrender by selling out.

I offer CNBC as evidence of the above in this way, In 2006-2007 my friend Dr. Froelich was a constant presence on CNBC and Dr. Roubini was a fringe character unknown to all but the most serious of us wonks. I’d love to plot a chart of CNBC mentions of these two folks versus the S&P. I will posit that it’s a trailing indicator though. Also of note is that as bear markets wash out investors, and therefore CNBC viewers, it is in their best interest to see the market roll up. In light of this, their bias has the potential to be intentional, and is a topic for another essay.

OK so where am I going with this?
Well if you examine this closely you find that it is a perfect system to separate the most people from their money. Lets look at two types of players and their two subtypes. Bulls and Bears, leaders and masses.
The Bull leader, trumpeting the bull cause, buy buy buy, is fully invested and full of bluster bordering on hubris in Oct 2007 (DJIA 11000).
The Bear Leader, screams from the tunnel of oncoming trains, is fully short in Oct 08 (DJIA 9000)
The Bull masses hear the leader but they are timid, they remember the bad times but they’ve missed this rally, they see the leaders, the CNBC pundits, now in full flourish, and they want their piece, they’re fully invested in Oct of 2008 (DJIA 14000)
The Bear Masses are crushed, they see their 401k is down 50% or worse, the investments they made when they got into that Scottrade acct because their brother in law was raking it in in 2008 are gone, they see the CNBC pundits predicting end of the world scenarios, they are totally out of the market in Mar of 2009. (DJIA 7000)
Now here is the rub, the masses are only one group, the same group, just at different times in the cycle they change from one side to the other. As Bernard Baruch said, “The main purpose of the market is to make fools of as many men as possible”, so the masses repeatedly switch to where the most damage can be done to them. The Bull and Bear leaders may survive if they maxed out enough in their time to sustain themselves, Dr’s Roubini and Froelich are probably ok, they are very smart fellows and during their times they are wildly successful, for the less talented it’s unlikely. They are generally replaced by younger versions of themselves, and the cycle begins anew.

Who’s left? The Unbiased, or since I am not a believer that such an individual exists, those who can reduce their bias to the point where it doesn’t impede their ability to profit in any market. I believe that if you wish to succeed in the market (and if you don’t, call me and I’ll see you achieve you’re goal), you need to understand you have a bias, and develop a methodology that limits the effects it has on your trading or investing. Backtest it in all market conditions, and when you’re sure it works stick to it with rigid discipline.

If you don’t think you have a bias, I think you’re wrong, but I admit a serious bias against that position.

I cannot recommend a specific method for reducing bias, there may be different methods depending on the bias itself for all I know. I guess this all fits in under the rubric of trading psychology. A couple of folks who’s writings on the subject that I have found useful are:

Dr. Brett Steenbarger http://becomeyourowntradingcoach.blogspot.com/ and on twitter http://twitter.com/steenbab
Denise Shull http://traderpsyches.com/ and on twitter http://twitter.com/traderpsyches

It important to realize that bias is everywhere, and it comes in both intentional and unintentional forms. One must cleanse oneself internally of the latter and one must guard against being influenced by both in the information one relies upon to make decisions.

More on the bias of others, in an upcoming essay.

Aiki14


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