Recently I have had the delightful task of presenting my short talk on behavioural finance to professionals up and down the country. The talk has the catchy title: Bulls, Bears – We Are All Sheep. It is a lunchtime, one hour presentation which I have been giving recently to UK regional CISI chapters.
Bulls, Bears – We Are All Sheep is a popular talk. Once an Australian bank flew me to Hong Kong to give the presentation over lunch to some of their important prime broker clients. I quite literally went to Hong Kong for lunch and did not actually have any lunch. My recent list of venues has not been quite so exotic: Liverpool, Leicester, Norwich, Bournemouth, Guildford and last week in delightful Exeter. Coming up are Manchester and Guernsey. I hope more local CISI chapters and others* will ask for the talk. It is fun for me to see my own country. The audience has been predominantly wealth managers (or stock brokers as we used to call them), portfolio managers and some compliance people. They are used to talks like: Money Laundering, are you sure? or MiFED II Update. Well its a great opportunity for me to give an informative but light-hearted presentation of a very important subject in modern finance. Rarely do people get to laugh while earning their CPD hour.
Choice of Regrets
In part of the talk I illustrate and aspect of Prospect Theory. We are discussing probabilistic alternatives that involve risk. I give an example as follows: Mrs Neil ( a.k.a. she who must be obeyed) allows me to buy only one lottery ticket each time. This is a strict rule. I have bought a ticket for every lottery since the National Lottery started in 1994. Every week I have chosen the same numbers, my daughter Lydia’s birth date. I have never won. Last week a good friend of mine who is an actuary and whose IQ is off the scale told me he had worked out what this week’s winning numbers would be and he told me the numbers. Now I am faced with a horrible dilemma. I can only buy one ticket according to the orders of She Who Must Be Obeyed. Should I stick with Lydia’s birthday numbers or choose the numbers my friend has given me? I ask the audience. Most choose that they would stick with the numbers that had been used without winning anything rather than switch to my super-bright friend’s tip. (Some don’t trust actuaries – fair point). This is essentially making a choice between two ante post regrets. In general people are most likely to choose the former choice because they have emotional capital built into that choice. So many tickets bout with that one number. Imagine you, for the first time, switched to another number and Lydia’s birthday came up? You would probably top yourself. It is not a utility choice, as financial theory would assume, but an emotional one. Audiences always, although not unanimously do the same. It is a fun but illustrative experiment.
I Have a Choice of Regrets Today and Now
As a trader this comes up often and has done right now. I use a systematic approach to trading. My computer tells me what to do and I follow it. I know the computer knows best because it is emotionless and I am not. This has worked for me for years. Not every trade is profitable but I have confidence and the long run has shown this is the best way for me. But this week, Tom DeMark, someone for whom I have enormous respect and who has made some spectacularly great market calls over the years has announced we are at a low in the US stock market. I do not listen to many people but I do listen to Tom. His current market calls are here in this Bloomberg TV interview. See also my Blog post.
I am short the S&P through an ETF and have a fair number of short CFD equities here in Europe. I am sitting on large open profits because I am leveraged and made my first sales months ago. But, due to the sharp falls my stops to cover and secure my profits are way above here. I think we are headed much lower. Having wide stops is how you make big money as the journey down will be a zig-zag. But wide stops leave you very vulnerable to market turns, particularly sharp turns. Bear market rallies, I know from experience, can be vicious. So I am scared. I am really scared because Tom has told be we are at a bottom. What should I do? This is a choice of regrets. do I stick to my system which has been generally good for me over they years? Or I act on the tip of my esteemed friend and put the money in the bank? Only time will tell which is right but I must decide.
I have decided, as behavioural finance experiments predict, to stay short. I have emotional capital built into my system. It has worked for me for years. I have to believe in it. I will certainly kick myself though if I find I was told it was the low and failed to close out all these lovely open profits right at the low. So there we are. The die is cast. I will stick to my system and hope that Tom is wrong or that the lows are made gently to allow my stop to come down. Prospect Theory is painful in real life. It is one of the pressures we traders and portfolio managers face frequently and one that can easily be our undoing. By the time you are reading this you will probably know what happened next. An I crying or relieved? Will I need a hug or be buying the drinks?
Trevor Neil @TimingWithBETAgroup #BETAfinancial
*I am available for client lunches, short presentation, children’s birthday parties. Also for courses in technical analysis skills as part of your firm’s Learning & Development programme. Pay me and I will come. Get me away from the screen.