Cashing in in 2010

A link to a fine article written by Bob Frick over at http://www.kiplinger.com/ on poker and investing - specifically how working on the former can greatly improve your skill in the latter.

The article features insights from MarketPsych's Frank Murtha, as well as from Daniel Negreanu, which - if you're a poker fan - is always at treat.

Fun and interesting stuff.

MarketPsych offers advanced coaching/seminars to traders, financial analysts, financial advisors, money managers as well.

If you want to get better at your game, give us a shout at info@MarketPsych.com for more information.

Cheers. And good luck in 2010.

Dr. Frank Murtha

NOBODY EXPECTS THE SPANISH INQUISITION!!!

My home page is the Yahoo! Finance page. There are two reasons I chose it: 1) If I want to check a stock price, or market action, I can do so with just one click; 2) The pre-market headlines crack me up.

Go ahead, check them out yourself one day. You will find that they are generally rendered moot/outdated/incorrect within the first hour of trading.

Look, I'm trained as a psychologist. I look at things differently. It probably makes me a "bit of an odd duck", to borrow a phrase from my father. (It's true. Ask any of my remaining friends.)

But you don't need to be the quirky type to see why this (lead) sentence from the pre-market headline article is just silly.

"The number of newly laid off workers filing claims for unemployment benefits unexpectedly rose last week as the recovery of the nation's battered labor market proceeds in fits and starts."

What's wrong with this sentence? Well for starters it notes that unemployment claims rose "unexpectedly" last week. Later on in the same sentence, it notes that the labor market "proceeds in fits and starts."

First of all, all economic forecasting is incredibly complex. Why a rise of 1% rather than a decline of 1% for one lousy week's worth of data rates as a "surprise" is beyond me. It's like standing in a rain shower and saying you got hit by a particularly unexpected raindrop. (Really? Didn't see that one coming??)

But the second clause of the sentence says the market proceeds in "fits and starts". Yes, it does. Truly. It is a point that is universally acknowledged. So how can you be suprised by a slight decrease while simultaneously noting the market proceeds in a herky jerky fashion?

For crying out loud, pick a side and stick with it!

Behavioral finance research has taught us how rarely data conform to our pre-supposed parameters. We know a coin will come up heads 50% of the time. Yet somehow we find ourselves wanting results to alternate heads/tails when we flip it. We see a run of 3 or more heads in a row, our pattern-seeking brains screams, "anomaly!"

It's not an anomaly. It is the essence of randomness.

Back to the article; if you read it in its entirety, you will see just how complex the jobs data are. You will find yourself wondering if the first paragraph still makes sense by the end of it.

The skinny: When it comes to a week's worth of economic data, market movements... the weather, don't "expect" anything.

It is sillyness that calls to mind this famous bit of sillyness .

I'm going to have my coffee now.

(Entirely too much sillyness.)

-Frank Murtha

Profit When Market Patterns Shift

All trading systems work. All trading systems fail. It is difficult to find a trading system that DOESN’T work in some market at some time. It is also difficult to find a system that DOES make consistent returns in all market conditions.

Here is the really good news.

Independent traders have the luxury of picking and choosing their trades. They don’t have to trade all of the time. This is their edge. They can wait until the market patterns are working for them.

It is in the evolution and transition of trading patterns that a lot of money can be made and lost. Because trading patterns are driven by humans who trade repeatedly with the same behavioral responses the destruction and emergence of new patterns create profit opportunities.

The problem we have as traders is that if we have a system that is making money in one market pattern, we get attached to that system. We build our ego on the fact that 15 of our last 18 trades were winners. This rewards our dream that we have found the secret to trading.

It’s like one of those Zen puzzles…any belief you are attached to, the market will destroy. As a trader, it is your ability to see new trading patterns emerge that create the most profit potential. To do this, the mind needs to see the markets as they are without the prejudicial filters we all carry around. If our ego is attached to a trading system and its success, the ability to see new patterns emerging is difficult.

When I was an option floor trader, I would get a “sense” that a market pattern was about to change. This “sense” was built on years of experience. Even though I might not be able to articulate what was happening, I could feel it.

At these times I would go to the market to reduce my risk. It was expensive because I would have to trade with other market makers to change my positions quickly. More often than not, nothing had changed. I would have paid $10,000 or more for the insurance. However, a few times a new pattern would emerge and I could see it because I didn’t have positions based on the previous pattern. Other market makers, with large complex positions based on the previous pattern would need to believe that the current change was an aberration and that the markets would come back to their previous patterns. As the market continued the shift, it would get more and more expensive to realize the losses, and the more stubborn these market makers would get.

Here is the cool thing. Since I no longer had a risk position, a few times I was able to visualize the new patterns very early in the shift, reset my option volatility tables and start building a new position. I would often be trading with other market makers whose values were based on the previous patterns. Slowly, one by one, the other market makers would see what was happening and the options would come in line with the new pattern. With the new option values, I made a lot of money.

As a market maker, I had to be trading and make markets for incoming orders at all times and it was expensive to shift positions. But as an independent trader, you can pick and choose the times to trade. This is a powerful advantage. You can get out of a position with a click of the mouse when you sense a market pattern is changing.

Here are some potential indicators of changing market patterns:

Psychological:


-Unusual Emotions in yourself such as exuberance, fear or cockiness
-Emotions in other traders you talk to such as exuberance, fear or cockiness
-Overwhelming consensus of where the market is going
-Physiological changes in yourself such as stomach pain, tenseness, funny taste in your mouth, back ache etc.
-Emotions in the news and headlines

Market Indicators:


-Volume
-Daily Range
-Volatility and implied volatility in options
-Momentum
-Size of trades or unusual large orders
-New chart patterns
-Unexpected price moves
-Time of day pattern shfits
-Opening market patterns changes
-Closing market pattern changes
-Changes in your ability to execute trades
-Changes in your P&L patterns
-Unusual price gaps
-Sudden quiet
-Shifts in how the market reacts to news
-Changing margin requirements

Remember, all trading systems work during certain market periods. All trading systems eventually fail. It’s the law. If you can free yourself from the belief in your system as the holy grail, you can see new patterns as they emerge and profit.

Easy to say, but how do you see new patterns? In my coaching practice we create a series of Mind Muscles™. These are neurological circuits that help us create new responses to market conditions. Creating concrete visualizations is one way of building new Mind Muscles™ and behavioral responses. If you want to create a Mind Muscle™ for new pattern recognition try this exercise.

First, get comfortable in a place that you won’t be interrupted. Take a moment do some deep breathing exercises. One exercise that works well is to slow count to three on your inhale through your nose. Hold the inhale for another count of three. Exhale through your mouth to a slow count of three and rest at full exhalation for another count of three. Repeat 10 times or until you feel your body settling in.

Then close your eyes and imagine a dog, a well trained bloodhound. He is sniffing the air, the ground and various objects. Imagine this hound dog in detail, his colors, movements and sounds. He is looking for some scent that is out of the ordinary. Spend some time with him as he sniffs his world. Now give him a name. Sniffer works great if nothing else comes to mind. Call the dog to your side. Pet him and give him some love. Then tell him to go and sniff out new patterns and to bay at the top of his voice when he finds one. Call him back, reward him with love, and send him out again.

Now, when you are trading and have a moment, visualize your new bloodhound. He represents a new behavior you have created in your brain. Call him by name. Give him some love. Tell him to go sniff out pattern changes. Watch him as he sniffs both psychological indicators and market metrics. And wait for the baying to begin.

For more on the how and why of creating Mind Muscles™ please call.

Richard Friesen
RFriesen@MarketPsych.com
415.259.0652

You have Gone Favre Enough!: Leading a Portfolio Comeback

The NFL is back and for the 18th consecutive year and so is Brett Favre.

I was watching the Jets in New York when the network went to a game update - Vikings vs. 49ers. Favres Vikings were down 24-20 at home to the upstart Niners. With time for one play remaining on the clock, Favre dropped back but was quickly flushed from the pocket. Scrambling desperately, with the final seconds ticking away, Farve stepped up and threw a pass about fifty yards on a line to the back to the back of the endzone. Miraculously, with two defenders all over him, Gregg Lewis plucked the ball out of the air and got two feet in bounds and - Pow! Lighting strike! - the Vikings had won the game.

The crowd at the Metrodome went nuts. His teammates mobbed him at midfield. And the sports cliches came poring in -- Brett Farve, the river-boat gambler! Farve, the old gunslinger! Hes done it again! It was truly an amazing comeback.

And because I am a geek, it made me think of investing.

If you’ve been in the game the last few years, chances are you have been losing too; your net worth that is. Yes, the major indices have rallied considerably in the last 6 months, but all in all those indices are still down approximately 40% from their highs.

Investors want a comeback. But how do you lead a comeback in these circumstances? What does it take to get your portfolio back on track?

The choice comes down to two major sports cliches that any NFL fan (sports fan in general, really) will recognize. Do you try to make make something happen? Or do you take what the defense gives you? The choice for investors is clear.

It can be very tempting to go for the latter and try to make a play. You know, like Brett Favre did. Youre down big. You feel restless, like time is running out, you have to make a play. In football these plays are often called Hail Marys. In investing they are called, well, Hail Marys.

It’s the same play. High risk, big reward, chuck the ball down field into heavy coverage and pray your guy is the one who catches the ball. That is essentially what Favre did. And in his case it was the right play.

When Favre threw his last second pass into heavy coverage, he had no alternative. Could his pass have been intercepted? Absolutely. (And knowing Brett Favre, there’s a good chance it would have been). But the clock was about to run out. He needed a touchdown to win. Not only was it an acceptable risk in this case - it was really no risk at all.

But for investors, even though the temptation can be overwhelming, trying to make something happen is the wrong call.

Football games have binary outcomes. You either win or you lose. (Yes, technically you can tie. But that is an extreme outlier). The object in any one game is to win, so sometimes you have to take risks you ordinarily wouldnt like to.

But investing success is not measured this way (e.g., 2 million dollars or die trying!) Framing one’s investments as all or nothing/win or lose is one of the absolutely worst traps an investor can fall into. It causes us to take foolish, reckless chances - the equivalent of throwing into triple coverage. In a football game with a minute left in the 4th quarter there can be nothing to lose on a play. In investing, it just feels that way. You can always lose 100% of what you have.

In addition to a win/lose framework a second difference is that the clock doesn’t run out on your investing - not like it does in a football game anyway. It is ticking, and thats part of the problem. Sometimes the clock seems to be ticking so loud that it’s all we can hear. But the bottom line is we do have more time left. We don’t know how much. In some cases decades, in other cases much less. But barring the most extreme and unusual circumstances, we are not in a position with our investing to say, I need to make 50% on my money by the end of the year or its game over.”

And even when our biological clock expires, our investments do not. They get, in most cases, passed on to the people we love, spouses, children, grandchildren.

The right way to lead a portfolio comeback is to take what the defense (read: Market) gives you. That is not a code for be ultra conservative. By all means take advantage of cheap valuations. Adjust your asset allocation. But let your choices be dictated by opportunities, not a desperate desire to make it all back on one play. You may find that the supposed long, slow climb back can happen more quickly than we expected - and without advanced warning. Those with broad equities exposure have seen just that in the last 6 months.

Maybe your comeback has begun. I hope it has. Or maybe you have been on the proverbial sideline. If the latter is the case, you may feel an even greater temptation to make something happen. Resist this temptation. Evaluate your goals. Evaluate your holdings. Evaluate your opportunities. And start making sound, measured decisions. Do it. Take what the defense gives you and you will come back.

There is only one Brett Favre.

And as any Jets fan will tell you, he led the league in interceptions last year.

-Dr. Frank Murtha

MarketPsych on TV

Been a little remiss in my blogging the past month, but I wanted to update folks.

I will be on CNBC Monday morning (supposedly between 10:30 and 11:00 AM) with Erin Burnett and Mark Haines talking about Fear and Market Bottoms.

So tune if you wish.

And congrats to Richard and the MarketPsy Asset Management crew who have been riding high through these turbulent markets. When it comes to secret formulas for deliciousness, there's Coca Cola, Kentucky Fried Chicken... and MarketPsy.

Yeah, But Are You "Sure-Sure"?

Ivory soap is famously 99.44% pure. I like that extra 44/100s. It gives me peace of mind.

If only financial forecasters would follow the Ivory model in their predictions. I've been hearing/reading/seeing a lot of expert predictions these days. New calendar years and volatile markets seem to attract them.

Now, let's be clear, I don't have a crystal ball. (I do have a Magic 8-Ball. But when I asked it if the Jets would make the playoffs it told me "Signs Point to Yes." So I'm thinking it's busted.)

The only predictions I will make with any confidence are these:

1) All consensus predictions will be too narrow in scope.

2) People will overuse artificial parameters in the form of round numbers and calendar years when formulating those overly narrow predictions.

Okay, I cheated.

Those aren't predictions. They're observations of human behavior that are among the most reliable you will ever find.

How reliable? Research into the area that behavioral finance folks call "overconfidence" indicate that when people are asked to predict a range in which they are 99% confident results will fall (i.e., a 99% confidence interval) they are correct 80% of the time.

Now at first blush, that may not seem so awful. 80% vs 90-something%...what's the big deal?

But it is awful.

Truly, horribly, make-you-want-to-toss-your-cookies awful.

Why?

Think of the corresponding behavior in light of such predictions. When we're 99% of something, it's basically as close to saying we're absolutely certain as we're going to get.

You could go Ivory Soap and say 99.44% certain but when we blurt out, "I'm 99% sure that won't happen", we're essentially saying, "No shot in hell."

That's dangerous even when it's TRUE.

Once in a hundred years was the standards to which they built the New Orleans levees. That works fine... right up until your neighborhood has to be airlifted off the rooftops.

But with market predictions, it's 20x worse. Events that people - and this includes experts, mind you -- say would happen every 100 years (1%) - happen EVERY FIVE YEARS (20%).

Let's say you listen to a more conservative expert predictor. He/she is twice as good and are accurate 90% of the time.

That STILL means every 10 years we're going to experience something that "nobody" saw coming.

Nassim Nicholas Taleb wrote a book called The Black Swan. (It's not as good a book as Richard Peterson's Inside the Investor's Brain, but it's certainly worth reading).

Where are we seeing such predictions these days?

Oh... everywhere.

"Where do you believe the S & P will be a year from now?"

"How high do you think unemployment can go?"

"What are the chances you will have to cut your dividend, Mr. CEO?"

Remember, fellow investors, fight the danger of narrow framing and don't be drawn into sharing the outlook of those who look at the horizon through a key hole and tell you wide it is.

We have no reliable way of knowing how bad (or how good) it's going to get.

The key is to expand the scope of expectations and to have plans in place for even the most unlikely-seeming scenarios.

Think "Ivory Soap".

And good luck.

-Frank

(If you are interested in a MarketPsych seminar, please feel free to contact us at info@marketpsych.com. I'm 99.44% sure you will find our seminars valuable.)

CEO's do it.

Oh, Ye of Little Faith

Faith.

What is it? What does it mean to investors?

If something is provable, certain... there is no need for it.

You don't need faith when you already know.

Faith is for the times when you really don't know.

It's the belief in something despite a lack of evidence.

The essence of faith is doubt.

We investors are getting our faith tested these days.

Faith in policies that we were assured will fix the problems. Faith in the people who make them. Faith in companies who say their balance sheets really are okay. Faith that investing in stocks is a good and safe choice for the long term.

Algonquin Round Table raconteur, Alexander Woollcott once said, "Everything I love is either illegal, immoral or fattening."

Exactly.

Cheating vs. Owning Up?

Looking the Other Way vs. Taking a Stand?

Broccoli vs. Red Velvet Cupcakes?

You want a short and reliable guide to making the "right" choice?

It's the one that's most difficult to choose.

So here we have a market that is tantalizingly cheap (historically speaking) and absolutely terrifying.

What choice do you make if you have a long term horizon?

I say unto thee, brothers and sisters: Those who have faith in this market will be rewarded somewhere down the road.

I believe that. In fact, I'm acting on it.

But to tell you the truth, I'm just going on faith.

The Value of the Time Out

In the words of Dick Vitale... "Get a T.O., Baby!!"

The value of the time out to the investor and investors plural (i.e., "the market") is hard to exaggerate.

Whether it's FDR's famous "Bank Holidays," or suspended trading, or simply going for a long walk when you're tempted to make an impulsive trade, the "time out" is a major weapon in an investor's fear-fighting aresenal.

Why? Because fear FORCES us to think short term. It's simply the way our brains are wired. There is a sound biological/evolutionary reason behind this reaction.

When you're out gathering firewood for the cave and lock eyes with a large male Smilodon (read Sabretooth Tiger) who has just emerged from the glade, your brain simply CANNOT LET you indulge in thoughts like "what to wear to Zog's birthday party?" or "should I redo the cave paintings for the harvest season (antelopes are so "early pleistocene")?"

The Sabretooth has gone the way of the Dodo, but the evolutionary function remains. Intense fear still draws our focus on the here and now. As well it should.

This is where the time out can help. The ablility to take a break and regain our bearings (to "step out of the box" as Crash Davis would say) gives our amydalas a chance to stop firing. When that happens we can engage other parts of our brain. That's when we can pull up and out of the tailspin of panic. It's neurobiology. See Rich's critically acclained tome for more information.

This is, of course, the eternal struggle for investors: To pull out of the short-term focus and think big picture.

When we do calm our brains and revisit the situation, it doesn't mean our outlook becomes rosy. It just means we've given our brains the ability to reintroduce reason to our thinking processes - and perhaps a chance to spot the fantastic opportunities such crises produce.

A few days off may be just what the doctor ordered.

In the meantime, good luck out there, everyone.

Frank

The Psychological Prescription

This crisis is now fundamentally about psychology.

Trust is the oil in the engine of capitalism, without it, the engine seizes up.

Confidence is like the gasoline, without it the machine won't move.

Trust is gone: there is no longer trust between counterparties in the financial system. Furthemore, confidence is at a low. Investors have lost their confidence in the ability of shares to provide decent returns (since they haven't).

This is now a PSYCHOLOGICAL problem. That's what Frank and I do - manage psychology, so here is my prescription:

1. A show of financial force is needed. Confidence has been lost in the ability of any one institution or government to solve this crisis. Now, to restore order, EVERY major central bank in the world needs to stand shoulder-to-shoulder and say: "We won't let this system fail." What? I didn't hear you... "WE WON'T LET THIS SYSTEM FAIL!!!" That's what the business community in the world needs to hear. That's how confidence is restored. It has to be a HUGE intervention and very credible.
2. I've said for a while that if the bailout plan had passed the first time, it may not have needed to be spent. Sometimes just the idea of a price floor is enough. That requires action to demonstrate that there is a buyer of last resort who will establish that floor. Sadly, we've seen the weakness and pettiness of U.S. political leadership, which has terrified investors. And so the credit crunch continues.... Only coordinated action by governments with their hands on the money spigot can pour enough financial oil into the engine now.
3. We need to believe that a BIG entity or institution or consortium is in control, or plans to take control of sorting out the crisis. Otherwise the fear and credit contraction will continue.

That means that when the coordinated action happens, it can't be watered down, and it needs to include the sentiment EVERYTHING will be done to fix this. Less than urgent STRONG action is not enough. Everyday huge amounts of wealth and growth potential are being eroded. It doesn't have to be this bad, but it will if no one steps up to the plate.

Unfortunately, I'm concerned (as is the market), that no one with the power has the leadership drive or political will to get this done. There are huge political risks to this, and sometimes explaining the psychology of what you're doing is enough to undermine it. For that reason, the final solution will need to sound very mechanistic, but the fundamental effect will be psychological.

The implications of a huge coordinated bailout/buyout will be hard to swallow for many people, on philosophical grounds. They might say, "but how can you advocate what is essentially a worldwide regulator or central banking system?" To which I say, "would you prefer a worldwide depression?" This credit crunch and the current market panic is THAT serious. And it needs the appearance of such an entity, for restoration of global confidence.

We need a coordinated, BIG, credible, active, and absolutely forceful response that demonstrates who is in control (and it has to be a unity of governments and central banks with a strong leader). Maybe the IMF and Worldbank will come up with something at their annual meetings this weekend? Maybe...

Richard

DISCLOSURE: I'm net short equities.

Pressure Valve: Letting off Steam

Have you ever seen a steam pipe explode?

I did. I was in Boston driving down Boylston. I heard an explosion, checked the rear view mirror and what I saw looked amazingly close to the above photograph.

Market crises can create the investing equivalent of steam pipe explosions. Investors get caught between two competing pyschological forces that build up pressure:

On one hand, uncertainty causes indecision.

But on the other hand, when we are anxious, we naturally feel a need to do SOMETHING.

The result of these two psychological forces work against each other until -- Kaboom! -- the pressure becomes too much.

It's a vicious cycle and it goes something like this: Do nothing (and suffer), do nothing (suffer some more), continue to do nothing (suffer to the breaking point) then PANIC!!! (do something rash).

It's a wealth killer.

We need a way to let off steam, so that the pressure doesn't build to the point of explosion.

Now, let it be said that we don't give specific advice to investors here at MarketPsych.

Nonetheless, there are some tricks that people often employ to relieve the pressure.

One of the best pressure valves we have is to sell a small percentage of certain positions to free up some cash.

This works on a financial level, but more importantly it works on an emotional level.

Why does it work?

1) It fulfills a deep-seated psychological need to do something, to take back control of our lives.

2) It creates something safe. It lets us know that at least part of the money that was at risk, is now safe. We have less exposure to pain.

3) It gives us freedom. We now have money that we can put to work on our terms. Emotional forces can no longer compel us to sell what will we have already willingly sold.

4) It's a hedge against regret. We all have the same nausea-inducing fears of regret: E.g. "The moment I sell, the market will bottom out" or "It's going to keep going down, and I'm going to hate myself for riding it to the bottom." Selling a small percentage mitigates this crippling fear.

5) It allows us to reframe crises as opportunities. We know that market panics create opportunities. The problem for so many people is they simply don't have the cash available to take advantage of those opportunities. The ability to engage other parts of our brain is another fear-fighting tool that helps put investors back on a healthy investing track.

How much is enough? 1%? 5%?... 20%? Only you can decide. Sit down with your advisor and see where you stand.

If you would like more information on our trainings, please feel free to contact us.

In the meantime... good luck out there.

Frank

The Wicked Garden Effect (TM)

I don't know if you've noticed, but it's been a bumpy ride for "The Market" so far this year.

And by bumpy, I mean horribly nauseating.

Many of us have individual holdings that have dropped 20%.

And many of us have holdings that have dropped a lot more than that.

Now, if you managed to hit the eject button early on and have resisted the urge to grasp at the knives falling all around us, I offer you my sincere congratulations. You've held fast to Warren Buffet's first rule of investing, "Don't lose money."

But if you're Un-Buffet-Like (and most of us are), you may be holding some positions that are way down. And if you need to clear up some cash, you may be put in the unenviable position of having to sell stocks when you'd prefer not to.

The question becomes; which stocks do you sell?

Here's a question: Imagine you've got two stocks in your portfolio. Stock A is up 25% from your buying price. Stock B is down (ugh) 25% from what you paid for it. Given just this information, which one would you be most inclined to sell?

What does your gut tell you to do in this situation?

Go ahead and think about it for a moment.

I'll wait.
...
...
...

Which one did you pick?

If I were a gambling man (and I am), I'm going to say you picked stock B. Most people do.

Now, Stock B may indeed be the best choice to sell. We have no way of knowing in this scenario.

But reflect on the reasons, the inner justifications for your decision above.

You may find yourself thinking things like.."It'll come back" or "Now is a bad time to sell" or "I can lock up a gain if I sell stock A" or "Why didn't Dirk Benedict get more work after he did The A Team... he was cool as hell on that show?")

Sorry. Got a little off track on that last one.

The desire to sell the winners in our portfolio, but hold the losers is a phenomenon that we at MarketPsych call "The Wicked Garden Effect."

We call it that because it's the investing equivalent of clipping all the flowers in a garden, and watering the weeds. And in my book, this is the worst mistake investors make. Over time you are left with a garden that is overrun by weeds, and the flowers have long been gone. The effect is devastating.

You may recognize this tendency in yourself or even recognize a couple of accounts that have become like Wicked Gardens.

Behavioral finance would cite the concept of Loss Aversion as the culprit. And they'd be right. But I view it as allowing our emotional needs (e.g., to feel good about ourselves, to not be a "loser") to override our financial needs (e.g., to invest in the best companies, to make money.)

Unfortunately, the price for feeling okay about ourselves often comes at the expense of our returns.

How do you defend against the Wicked Garden Effect?

1) Be aware of this powerful tendency.

2) Use solid objective criteria on which stocks to sell. (This is tough. It requires research and thinking... do it anyway.)

3) Identify the emotional need behind the sell decision and get some leverage on yourself. The fool isn't the one who made a mistake. The fool is the one who can't admit it.

For those who are interested, MarketPsych does (fun and interesting) investing workshops, trainings and presentations that explore this and other concepts.

Happy Investing.

Frank

Negative Expectations at Their Highest in History

Our MarketPsych index of negative stock market expectations is now the highest we've ever seen (we've got data back to 1984).

The Fed's actions and words -- explicitly committing to bail out mortgage lenders -- should have lowered market negativity. Instead we got a morning rally afterwards and then further selling.

What we saw last week was everyone jumping ship - a real crowd effect. The only information driving investors was downwards price action and rumors of further collapses. The more stocks dropped, the more they sold. A positive feedback loop was created.

In psychology, a positive feedback loop is created when people base their opinion of how bad a situation is on the actions of others. When everyone is doing this, we can usually call it the peak of a mania or the bottom of a panic.

The market stopped being comforted by the Fed, which is a bit scary. Fortunately, it was primarily the financials getting hit today. The Biotech index was actually up 4%. A rally is certainly near (though I was wrong last week).

Eventually, when the supply of sellers decreases, because they've run out of shares or capital to sell, positive feedback loops can't sustain their negative price momentum.

The danger is that acting on negative expectations can become a self-fulfilling prophecy. I wrote about this in my book, with the example of Brazil's near debt default in 2002.

Essentially, the more investors avoid new bond offerings, and the higher rates go (especially for junk bonds), the more squeezed are companies that need to raise capital. Eventually many will go bust because they can't afford the high interest rates (which are high because investors are afraid the companies will default). If the rates had been lower (because investors were more calm), then the debt would have been service-able and the company would have survived. The crowd's pessimism really can make things worse (just as its optimism was problematic in allowing such overconfident risk taking through 2007).

At this point, it's important to ask "can it get worse?" (yes), "will it get worse?" (probably), and "has this been priced in?" (in many sectors, yes, much too much).

In financials it's not clear to me if it has been priced in, hmmm.... A rally in financials won't happen until we know where the next bogeyman is. And right now, there are lots of terrible rumors, but no new sources of pain. I think investors are waiting to see how the current pain will spread, since it's clear that the economy is slowing and the real economic slowdown hasn't been reflected in the numbers yet. "Who's next to collapse?" is often heard.

There are some amazing bargains out there. A stock or bond screen will demonstrate great values. I don't trust the numbers on financials (never have), but in some traditional industries low debt stocks with PEs of 6 and trading under their book values are much more common. I won't get specific because the blog is about psychology, not stocks picks at the moment.

But watch out for stocks vulnerable to the self-fulfilling prophecy of higher interest rates for "risky" bonds. That's whay I mentioned to look for "low debt" stocks.

Solutions to the current crisis include better political and regulatory management of the psychology of risk-taking, which isn't likely anytime soon (as I mentioned in my last blog post). It will take some deep understanding of human behavior in the Fed and SEC (and maybe an in-house psychologist or two) before we get such enlightened policy. In the meantme, there will always be bubbles and panics to take advantage of.

Historic times we're in. Now let's make the best of it!

Richard

MarketPsych Says Let's Make A Deal!: What Would It Take To Buy You Off?

I'm going to assume that if you've visited our MarketPsych blog, that you are, in fact, an investor.

But what kind of an investor are you?

Do you invest for to get a financial return or to get an emotional return?

(Okay. That's a trick question. We invest our money for both reasons.)

But getting back to you for a momemt, what is your style? Which kind of return is most important to you?

Here's one way to get an insight; ask yourself this question:

Imagine that we at MarketPsych can magically guarantee you an average annual return on your investments, but in exchange you will forfeit your right to ever invest your own money again. In another words, for agreeing to keep your paws off your investments we will (again, magically) guarantee you ____ % per year.

Let's Make A Deal: How high does that percent need to be in order for you to agree to the bargain?

(MarketPsych Legal Counsel Disclaimer: The above is meant to be a playful exercise in the hypothetical. In no way is MarketPsych actually offering this deal. In fact, despite Richard's launching of MarketPsy Capital, which we are confident will be a big success, it is always irresponsible and unethical to guarantee market returns. Moreover, MarketPsych does not engage in wizardry, magic, alchemy or any other occult arts. Although Frank does own "lucky socks".)

Now, we know that the average return for "The Market" over time has been close to 10%. (Note: There is still some disagreement on this. How do you define "The Market" -Dow Jones Industrials? S&P 500? Russell 5000?)

But we know over time, major indexes have yield on average close to 10% For the sake of argument, let's call it 9%.

So if 9% is the average, what would it take to buy you off and have you completely delegate all investing to someone else (a financial advisor, for example).

Some investors will immediately say - "I'll agree to the bargain for 9% per year. After all, it's a reasonable return, a "fair" return."

Some investors will say - "Heck, I'll sign up 7%! If the return is guaranteed, I'll never need to worry again. It's worth a "below average" return for the peace of mind."

Some investors will say - "I need more. I like investing money. I enjoy it. And I think I can do better. I need 10%... 15%... 25%! to make it worth my while."

A rare minority will simply never go for it, at any price.

So ask yourself that question. No matter what your answer is; it will be revealing.

It calls to mind a true story of an avid poker player who also happened to be a day-trader. Let's call him, Mr. B.

Mr. B was losing at poker. He'd bluff too much. He'd play ill-advised hands. He'd refuse to fold. Fact is, he sucked.

He became sick of losing, so he hired a professional to teach him how to play winning poker. And lo and behold, it worked. After a few lessons, Mr. B began to see better results. He found himself making a little money, and slowly began to build a bank roll.

And after 2 months, Mr. B quit playing.

Why?

"Too boring," he said.

So was Mr. B playing the game for financial reasons (like he thought), or was he playing for something else, to satisfy emotional needs?

And what exactly were these emotional returns that he valued above financial returns?

Knowing the answer to the above question in red is a great first step to knowing where your investing values, strengths and vulnerabilities lie. All other things being equal, such knowledge makes you a better investor.

We also offer you another deal, to come to one of our Professional Seminars (there's nothing else like them out there - don't be fooled by imitations!) whether one designed for everyday investors, or for investing professionals.

Cheers.

Nice Call, Master Yoda

Market: I'm not afraid!

Rich: You will be.... you. will. be.

Regarding your previous post, you may not have to be worried about the absence of fear for long.

The MarketPsych Fear Index has seen an uptick recently.

One reason I believe it has meandered of late is that a critical and catalyitc component was missing: The appearance of a nightmare scenario that the individual can; 1) experience viscerally, and 2) consider credible.

The Bear Stearns news today presented just such a scenario, and it sent a shockwave of fear through the markets.

We simply do not live in a world where "Modest CPI Numbers" can compete with "Wall Street Institution Imploding Overnight" in a market-moving contest.

If it sets off a "fear cascade" (think dominoes), we may just see Market Panic make it's first reappearance in years.

Getting my cash ready now...

How To Scare the Pants off an Investor

Fear may drive the markets. But when it comes to scaring investors, most people are amateurs.

Take all these doom and gloomers you see on TV. I bet they think they're reeeeeeally scary. With their "GDP numbers" and their "recession forecasts".

"Well, Sue, it's pretty bad out there. In fact, we've upped the likelihood of recession from 45% to 52% by Q2." (Pause for reaction).

Is that supposed to scare me? To you, I say, "Ha, would-be fearmonger! You've got nothing! I've seen Barbra Streisand movies that are scarier than that!"

(Actually, I find all Barbra Streisand movies utterly terrifying... perhaps that's a bad example)

You know why their analysis isn't scary? Because it's not emotion... it's math. I mean, you're not even engaging the right part of the human brain! (Dr. Peterson's opus is the definitive source on that subject).

"Uh, wait. There's a 52% chance of recession... but only a 76% chance of that. And that's only if LIBOR drops under 4%... Hold on, let me get my calculator." I mean, honestly.

Math is only scary when you're in 5th grade and are asked to go up to the blackboard and do long division problems in front of the class (and you know Mrs. Schecter picked you because she caught you passing notes to your buddy, Rob earlier in the day).

You want to know how to really scare the pants off investor? You want to really know how to get the stampede started?

First off, ditch the math. The odds of experiencing a loss don't scare people; it's the amount of that loss that scares people. This is the first crucial step toward sewing fear. Ever seen that show, Deal or No Deal? (e.g., I know my odds, but I could lose a guaranteed $300,000). It illustrates the difference beautifully.

And it's not just the degree of loss. Even that's still numbers, and number is the language of math. It's how those numbers will impact the quality of the investors' lives that generates the fear.

Investors have to imagine what they will feel like when the loss changes their lives. That's what turns their stomachs.

Also, fear is personal. You want to scare investors? You gotta make it personal.

You pictured sending your beloved son to an Ivy League School. You pictured walking across the quad and soaking in the beauty of the gorgeous Georgian style buildings and 300 year old Elm trees. How proud you would feel. Nothing but the best for your son! But...

There's no way you can afford that now. Your vision and his dream have been crushed. Instead, imagine the sense of shame and longing when you pull up to that shabby dorm at the state school with it's ugly utilitarian architecture. The best companies barely even recruit there. He'll never get the opportunities there you envisioned for him.

(MARKETPSYCH LEGAL COUNSEL DISCLAIMER): State schools provide excellent educational experiences. The quality of education is often superior to that of private colleges. In fact, Marketpsych founders have attended public schools, proudly. Moreover, many state schools have lovely campuses. They are not necessarily ugly or utilitarian, with the exception of the State University of New York at Buffalo's Amherst Campus which was apparently outsourced to the Soviet Ministry of Architecture in 1971.)

Not scary enough yet? Fine. You know that 0ctogenarian who was behind the counter at that chain book store? Remember the twinge of pathos you felt? Well guess what? You're going to be that guy because you can never afford to retire. Every morning you will put on your uniform, get the bus to the mall and spend all day on your aching feet squinting at book prices because your eye sight "isn't what it used to be". At lunch you will get a half an hour to eat the bologna sandwich you made that morning. You will be doing this the rest of your life.

I think we're getting warmer.

Lastly, add some regret. (i.e., And not only did this awful thing happen... but it was all your fault!)

Of course, different investors imagine different worst case scenarios. But we all have them. Wheyn you create the connection from how their investing loss would lead to that terrifying reality, and the investor actually pictures themselves in that situation and feels what it would feel like... that's when you really.

Fifty-two percent chance of a recession?

Whatever, math-guy.

Talk to me when we get to the catfood.

The Market Prediction Game: Here We Go Again...

There's been a lot of activity in the markets so far in 2008. We've seen uncommon (though harldly unseen) volatility. And with volatility comes one of "The Street's" favorite pastimes; The Market Prediction Game.

But how do these predictions tend to pan out? With talking heads doing their talking thing everyday, it's hard to keep track of the daily (hourly?) deluge of prognostications.

But when we do collect the information, it is telling. The Wall Street Journal surveyed top economists semi-annually, to get forecasts on what bonds were going to do over the next 6 months. The data go back to 1982.

The experts (intelligent people all, to be sure), were wrong in the predictions of the direction bond yields 66% of the time. That is to say, when asked 6 months from now will the yield on a 10 Year Treasury be A) Higher or B) Lower... they got it right 1 out of 3 times. (Source: Davis Advisors)

Do you realize how bad that is?

Employing a black-tailed marmoset to throw darts at a board marked "higher" and "lower" would be a better predictor!

MARKETPSYCH LEGAL COUNSEL DISCLAIMER: Marketpsych.com does NOT promote or otherwise endorse the practice of marmoset dart throwing. Sure, it's fun. But that's beside the point. Arming small, wiry primates with sharp objects for throwing is dangerous and most likely illegal in the US (with the possible exception of licensed establishments in the state of Nevada). Marketpsych partners are NOT responsible for damages suffered by those engaging in this activity.

The fact is, human beings are notoriously lousy predictors of future market events. A study by George Wolford and associates at Dartmouth College found that even rats and pigeons outpeform humans in short-term market prediction. (No word on marmosets).

This does not mean the market doesn't have cycles, or that patterns don't emerge. Indeed, to be wrong 2 out of 3 times (as the economists were on bond yields) lends credence to the notion that the predictions are NOT random. It points to the central theme of short-term reactivity that seems to dominate investing patterns - something we call Whack-A-Mole Syndrome. (TM)

My colleague, Dr. Richard Peterson, has written about it here in his superior book, and even developed the Marketpsych Fear Index which tracks how investor emotion is often an inverse predictor.

But the point is you don't need a crystal ball to be a succesful investor. You need a few simple but undervalued qualities. 1) The ability to recognize companies with proven records. 2) The ability to recognize when their stocks are at an attractive valuation vs. earnings. 3) The discipline to invest your money in them... and not monkey with it. (pardon the pun).

But we can't help ourselves. With so much information available, with so much money on the line, we love to engage in the Prediction Game. (By the way, Pats 34 - Giants 14 - you heard it here first!).

The Market Prediction Game reminds me of the end of the classic 80's flick, War Games (starring a young Matthew Broderick), when "Joshua", the American military super-computer aborts a nuclear launch on the Soviet Union because it realizes that it would result in mutually assured destruction. The computer learns the folly of the eponymous "War Game".

"Strange game. The only winning move is not to play."

Indeed, Joshua. So don't play.

How about buying some great companies cheap?

Or perhaps a nice game of chess, instead?

Hail to The Redskins! (Curse); Hail Victory!! (For the incumbents)

Did you know that when the Redskins LOSE their LAST HOME game, the INCUMBENT party has LOST every presidential election since 1936? Isn't that spooky!

Well, not really. It's more silly than spooky, I think we can all agree.

Plus, George W. Bush ruined the streak in 2004, so the "Redskins Curse" is over.

For those who are interested, Snopes (the site dedicated to debunking or validating urban myths) has more on the subject.

But it's still fun to see how our superstitious minds can craft tales of curses and omens and lucky charms that predict the future.

Let's take a look at the Redskins curse in greater detail for a moment and see how Behavioral Finance would explain the development of this myth?

Q: Why the Redskins?

A: The Availability Bias. We tend to use the information that is most handy when we make decisions/predictions. Washington is a political town where people pay more attention to elections. The 'Skins are the local team. It stands to reason that they'd notice a political or 'Skins related anomaly. (In Green Bay... not as much.)

Q: Why the last home game?

A: The Recency Bias. In a series of events we tend to remember the events that occurred in the beginning and, even more so, those that occurred at the end. (Let's face it, who could remember the statistic if it occured in week 5 of the season?) Plus, we remember events that carry greater emotional weight. Home games are more likely to be attended by the politically interested fan base. When you leave a stadium, you remember a win - as well as a loss. (Epecially if that loss was to the &*$#*@! Cowboys).

Q: Why did Redskins Curse exist at all, why the anomaly?

A: Probability. We know that the incumbent party has a natural advantage. We also know the home team in football has a natural advantage (usually at least 3 points according Las Vegas). It should come as no surprise that two events will tend to occur simultaneously when the probabilities are greater than 50%.

The question of predicting future events based on past events is an important issue for today's trader given the popularity of "back-testing" strategies (plugging in your future strategy to past events to see if it would have worked). Numerous online brokerages currently touting this method as tool for validating trading models. And it can be. But there is a fine line between back-testing and data mining. The key is recognizing that correlation does not equal causation.

Since the Redskins Curse is dead. I think it's time to come up with a new, cool curse. Doing so means engaging both sides of the brain. MarketPsych has provided a model below.

The Pittsburgh Steelers Curse for Democratic Candidates

STEP 1: Mine The Data (Left Side of the Brain - The Correlation)

First, you're going to need a stat, a several standard deviation event that makes for an interesting coincidence. Fortuntately NFL records provide a mountain of data in which to go mining. As you would with a stock screen, sort through every Steelers season on election years since 1936. Eventually, the screen will turn up some anomaly - a particular week, a particular stat - that has consistently correlated with Democratic Party victories. Let's say that this particular data holds up for week 7. (I.e., When the Steelers LOSE the 7th game they play in a season, the Democrats always LOSE the presidential election.) Got your stat? Good. Proceed to step 2.

STEP 2: Create A Narrative Around It (Right Side of the Brain - The Causation)

The left side of the brain will do the math. But the right side will "tag" it with a story. (More on this and other fascinating brain explanations in my colleague Richard Peterson's brilliant book.) The story needs to create some sort of plausible context that would support a potential reason for the anomaly. And the spookier, the better. Sometimes, the numbers do this for us. (Lucky number 7, hooray! The number 13, booo!). But there are many ways to create a deeper meaning for the numbers. Use your imagination! Tie it to a disgruntled player (maybe he wore #7 !) who's uncle was the Republican nominee. The Steelers traded him on week 6 and ever since that fateful day....

Personally, I like this one: The owner (Who owned the team before Art Rooney?) was an enthusiastic supporter of Franklin Roosevelt, and invited FDR into the locker room to address the team on week 7 back in 1936. FDR, fine orator that we was, gave the 'boys a major pep talk. He ended it with a promise. He told the assembled players that "If you win today, I'll guarantee you a victory in November... as well as lower taxes on steel products, moustache wax, and Polish Sausages!" (Hey, all politics is local, y'know?) Well, don't you know the Steelers rallied to defeat a powerful Chicago Bears team with a miracle last second pass. And ever since that fateful day...

Feel free to create your own. Just don't bother using the Jets. The whole franchise is already cursed.

Market Fear: The Poison and The Antidote

If behavioral finance teaches us one thing, it is that Fear trumps Greed. In fact, it's not even close. Fear is like the Harlem Globetrotters playing the Washington Generals. Sure, ostensibly it's a real contest, but despite the ups and downs along the way, we always know who's going to win in the end. The outcome is predetermined, inexorable.

(Authors Note: I used to use the Yankees and the Red Sox for this analogy. But then David Ortiz hit that home run off Mariano Rivera in 2004 and rendered my metaphor obsolete. A pox on your house, Red Sox Nation!!!)

Fear drives the market. Why? Because losing hurts more than winning feels good. Because the future is uncertain, and the default emotion in cases of uncertainty is fear. Because you're not paranoid, the Market really is out to get you, and fear is the greatest weapon in the Market's arsenal.

How do we fight our fear? With "reason"? Well, some people do. And by "some people" I am chiefly referring to Vulcans - the supremely rational beings from the eponymous planet who are not afflicted by such human weaknesses as emotion. (Then again, Vulcans mate only once every seven years, so you can see why emotions could be a big drawback.)

No. For most of us on Planet Earth, we are forced to fight the battle on an emotional level. Reason definitely helps, but only so far as it helps us reacquire our emotional equilbrium.

Fear is a poison. But there is an antidote - Control. Not actual control (which is irrelevant) but the belief that that you have control. Fear beats Greed. Perception beats Reality - at least where our emotions are concerned.

We have seen this play out recently on marketwide level with the recent actions of the Fed Charmain, Ben Bernanke. The market flagged due to fear. (It always does due to fear.) But the fires of fear were stoked in large part because one of the main sources of investors' (sense of) control is the Federal Reserve Board.

After months of hearing "Inflation remains our primary concern", investors began to wonder if the esteemed Dr. Bernanke really "got it". The Market was saying; "Does he understand our concerns? Does he even care?"

Investors were riding shotgun with the Fed Chairman on a dangerous road. They were concerned there may be a cliff up ahead, but they were even more concerned that the Fed Chairman was asleep behind the wheel.

The first shot of control was injected back in July when Chairman Bernanke acknowledged that the mortgage crisis (and credit crunch) were on his radar screen. (Whew! He's not sleeping after all.) The second shot of control came when he lowered the discount rate. (He's awake and he's willing to hit the brakes.)

People called his decision to lower the discount rate a "largely symbolic move". Exactly. Symbols are important, especially when the symbolic gesture tells people, "Relax. I'm on it".

The Market has been calling (or is it whining?) for an interest rate cut. And I, for one, think that would be splendid. But investors got something even more important. They got back their sense of control.

It's like the immortal words of Mick Jagger:

"You can't always get what you want, but if you try sometimes, you might find you get what you need."

Bernanke's awake. It'll do for now.

MONEY-MONET!

I was on CNBC on Thursday, which I enjoyed immensely. (Clip here). They wanted a "shrink" to provide commentary of the current market psychology. We know people are jittery these days. How could they not be? But we also know that panic costs people money big time. So how do you get back to the proper perspective?

Well, start by checking out the picture above. What does it look like to you? If your answer is "not much", than you have something in common with the vast number of investors viewing the market's behavior the past couple of weeks.

The photo above is a painting by Claude Monet. Monet was the founder of a new style of painting, French Impressionism. The style is marked by, among other things, "open composition" and "visible brushstrokes". What that translates into (apparently) is "make a bunch of dots and the dots become a picture."

Here's the thing to remember: A portfolio is like a Monet. If you get too close to a Monet, all you see is a bunch of dots (a phenomenon comically illustrated in the movie Ferris Bueller's Day Off when he goes to the art museum). The same is true with our portfolios. When we get too close, we see nothing but a bunch of dots. It's data devoid of context. The picture makes no sense, and when it comes to our investments, that's scary.

The key to appreciating a Monet or a portfolio is viewing it from the right distance.

(Waterlillies)

This means resisting the constant pull to look at our investments from a weekly... daily... (minutely?) framework. If you look at a chart of the past month, it will provide a frighteningly volatile picture of big ups and bigger downs that may induce a feeling of motion sickness. If you look at a chart of the past 20 years, it is much more likely to produce what Glenn Frey would call a "peaceful, easy feeling". Volatility is not the same thing as risk, if you have the right time horizon. Perspective is everything.

I'm speaking of course not only about the distance of time, but of emotional distance as well. When we get "too close" emotionally to our portfolios the result is the same. This is one reason why working with a financial advisor (or failing that, an investing confidante) can be so valuable. Sometimes we need someone to tell us, "Take a step back".

Like Sisyfus rolling his stone up the hill in Hades or me organizing my desk, it is a neverending battle because, as humans, we are constantly, unconsciously and inexorably and being drawn into a short-term focus. (It's happening right now. Seriously. It is.) That's the side effect of paying attention to our world and we can't help it. But if we can make ourselves aware of it, and that gives us a fighting chance.

How do you keep yourself aware?: Reminders. Whatever works best for you. One option would be to get yourself a Monet print to hang in your office. They're cheap, they're easy to find, and they make a nice reminder of how we can't appreciate our portfolios if we don't have the proper distance.

Plus people at work will think you're "classy". Which is nice.

CNBC INTERVIEW and Waiting 'till the Fat Lady Sings

NEWS FLASH: Marketpsych Managing Director Frank Murtha on CNBC today!!! See the video here.

Market fear is spreading, and that's a good thing.

This afternoon a stranger sitting next to me on the subway asked me how the market was doing today (someone who didn't know I work in finance). When anonymous strangers stop staring straight ahead, and start nervously inquiring after the health of the stock market, then it's about time to search for bargains. I figured that experience was the opposite of knowing it's time to sell when you shoeshine boy (or cab driver, or doorman) is offering you stock tips.

As predicted in my last blog post - shameless self-congratulation :) - the market would drop, bounce, and then drop again on greater fear. Below is this morning's market fear chart. Notice how investor pain has risen well above March's pain levels (this is a 7 month chart).

The sell-off will continue, in fits and starts, until the full depth of the (1) subprime mortgage defaults and (more importantly) (2) Credit (and thus liquidity) squeeze on borrowers is comprehended. As long as there is uncertainty, the markets will not rest, and the relief rallies will be only brief and tentative.

If the extent of overextended borrowers (and subsequent defaults) turns out to be as bad as the Chicken Little's are claiming (unlikely), then the market may not rally until congressional legislation is passed and it's ramifications are fully understood (not a good thing in the short-term). Such legislation would be intended to prevent further profligate borrowing by debt-weary consumers. And better credit monitoring and preparation for liquidity crunches (higher reserves) by financial institutions. As long as interest rates remain low, the expansion should continue with only minor economic consequences. It's just a waiting game now -- to see what the fallout will be, and then it will be time to buy.

Ah, but that's idle speculation of a nervous mind. We have had a pattern of profitable buying on dips recently (past 4+ years), and it's possible that many have become seduced by the ease with which they made money -- letting their guards down. That could end badly, or it could keep on. In any case, it will be safe to buy dips when the cards have all fallen and the hands are turned. We need capitulation, panic, and consequences. Then the liabilities of the losers will be known, and the mess can be cleaned up.

Happy Investing,
Richard