Successful Investing Requires Understanding of an Imperfect System

Consider the pure efficiency of the markets; a gathering place for those desiring to express their fleeting convictions on the future pathway of an asset.  The markets are an interstate weigh station of sorts – one where deeply-pondered assumptions are cast while simultaneously offering a helping hand to those clasping onto a frantic hunch.

Markets are unusual in that they don’t, by their very nature, discriminate upon age, pedigree, or gender.  They act as a switchboard connecting every sort of dream, aspiration, emotion, tidily transferring them into endless bids to buy and offers to sell.

Presently, we are sufficiently distracted by several hefty macro issues including the timing of the Fed’s first rate hike, the current intensity of the U.S. dollar, and the near looming earnings season - all of which could either skin the knees of our portfolios, give it a deep long-lasting bruise, or possibly nothing.

Yet, in the slow-moving train crash of our investment journey, what often takes a large coach off the rails altogether is neither the market itself, nor the events that shape the market. Rather, it’s our thinking or the way we think that ultimately does the most severe damage.

Investing with Stinking Thinking

Think of it this way: Assume that within your personal investment thesis you drift toward weekend hotel seminars, charts/graphs, options, newsletters, or even opinion from a brother-in-law hedge fund manager who speaks incessantly about how he can casually afford to garage two cars on the Upper East Side. Whatever it happens to be, these things ultimately shape you and your thinking. By reflex, you’re inclined to listen to precisely what you want to hear. No matter whether your thinking is shaped by daily memorization of the Wall Street Journal or taking advice from a slickly written pamphleteer, the results are similar.  These “things” are the container to get you into the struggle, but it’s not the contents you need!

Personally, I’m commonly enticed to believe that pending market movements can be accurately predicted through inferences within the option markets.  Other words, my decades of options experience makes me feel abnormally cozy with particular option tell-tales like implied volatility levels, implied skew and term-structure supply/demand percentiles.

On one hand, options extrapolations are decent indicators delivering me consolation and thus a certain level of confidence.  However, if I was truly honest with myself, I would readily admit that this reliance is a soft addiction to a way of thinking.  It gives me this idea of me being the lord of the reality of which I’m defining myself, yet actually I’m fairly imprisoned by it all.

Your Way of Thinking is the Only One

By nature, markets are wild: They don’t follow thought or reason with a system. Thus, they simply cannot be tamed.  Your way of thinking – your system - is just another denominational theology, while the markets are nothing short of a pew full of miscreant congregants.  Sure, systems can and do work – especially if you can successfully embrace the idea that your system  has little to do with order, certitude, clarity, reason, logic, or academic merit that supposedly lies beneath it.  You’re on your way to success if you can hold your system lightly and loosely, knowing it’s just a pacifier as you will never out think yourself or the market.

We want to believe we are in control, that we can manage the future, that we can make reasonable predictions about what lies ahead.  So, we look for order amid chaos all in the name of comforting ourselves.  We are not wired as people to understand abstractions, random gathering of clouds and stars, or natural or human events that offer no evident purposes.

We create patterns where patterns don’t exist.  We look at events, either calamitous or celebratory, and focus on what happened while ignoring what might have happened given a different set of contingencies. We don’t act with any statistical orderliness.  We change our mind on a whim.  We do stupid things.  We copy each other.  We panic.

Successful investing is all about human frailty and it can be – to an extent - overcome if you realize that your thinking is nothing more than an imperfect “system”, that your system is flawed and simply cannot understand anything or everything, and that none of us can be totally logical, rational, or objective when predicting what the markets will do even tomorrow. 

Your system or thinking needs to be wrapped with discipline, having nothing to prove, and treating monetary gains and losses with the same general disregard as we might upon discovery that we are reading last week’s newspaper while waiting for the subway.  All of this, while the rest of us remain safely within a world of ideas and opinions, roles of esteem and status which undoubtedly produce lukewarm investing results.