Daniel Kahneman’ – Trading, Fast And Slow

In Daniel Kahneman’s excellent book, Thinking, Fast and Slow, he investigates two systems of thought. The first is quick and automatic. The second, more focused on complex issues. Both employ heuristics, but in different ways. Both involve non-rational thinking.

 

Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital:

While I am borrowing the title and the general approach, it is not a perfect analogy. So much volatility driven by minor snippets of news. It is time to think about why.

Market Heuristics

The human desire for an explanation for everything drives social media. There must be a reason! The PBS NewsHour show today attributed the stock rebound to economic news. Forget that such news was reported either before the opening, or in the first thirty minutes of trading. Other sources assigned different explanations, but none were very credible.

In the last two weeks we have seen multiple examples of “trading fast.” Here is how it works.

1. There is a news-driven stimulus. These are all actual examples.
   1. There is a raid on the office of the President’s lawyer;
   2. One semiconductor company provides a clouded outlook;
   3. A tweet or an overnight speech hints at a change in trade talks;
   4. A news conference suggests higher (or lower) tensions with Iran or Russia.
2. Traders react. Most people do not understand the basic trader approach. You often “take a leg” leaning in a direction that seems to capture the mood of the market. If it goes your way, you ride it. If not, you try to scratch it for even or a small loss. Every piece of news has a simple evaluation: bullish or bearish.
3. Algorithms react. The top computer systems have learned the key words that are associated with market moves. These are even faster than the traders.
4. Technical traders react. The market reaction may send stock prices through levels widely viewed as important support or resistance.
5. ETFs that hold the key stocks plummet. Other companies in that ETF get slammed, even though their fundamentals are essentially unchanged.
6. Financial TV brings in the chartists, who cite the temporary breach of the 200-day moving average, the move of averages into “correction territory”—more than a ten percent decline, and the level of decline possible in a Fibonacci retracement. Take your pick!

The least valuable heuristic treats the market as a war between two sides. This approach offers comments like the following:

• The bears are in control
• The bulls must defend the 2500 line
• The bulls are absent – a buyer’s strike

And many similar statements. This is an entertaining way to (over-)simplify the market. We can all visualize a two-player game. Few can think about the wide variety of groups that are actually represented. Let’s turn to some facts.

The market participants

Those focused on daily news and an excessively frequent review of account statements might make a trade. More importantly:

• The clear majority of investors and managers were doing nothing;
• At the investor level, people were not even aware of the market volatility, at least until the evening news;
• The field was open for System one, short-term thinking.

The events

What is the rational interpretation of key events? This is just a starting point for astute readers.

• China response on tariffs. Pretty mild and not a surprise. It is a routine part of the current negotiation. If anything, the overall prospects for compromise have improved.
• Trump attack on Amazon. More of the same.
• Chip stock conference calls – basically good as confirmed by Apple.
• Overall earnings reports – new records, despite the few clunkers.

Conclusion

If you try to “trade fast” you are competing with top-flight competition. If you have analyzed stock values, and can ignore the noise, you may find it very profitable to “trade slow.”