Why you can not afford to be a bull or a bear
Posted by Danny on March 24, 2014
There are two types of people. Some people constantly change their theories and beliefs to make them fit reality better, while others try to change reality to make it fit their rather fixed theories and beliefs. In his book The Signal and the Noise: Why So Many Predictions Fail but Some Don’t, Nate Silver describes them as “foxes” and “hedgehogs”. The foxes are flexible and cautious, and think in terms of ever changing probabilities of possible outcomes. The hedgehogs are stubborn and confident and rarely change their predictions until they come true eventually. The fox is tolerant and open, the hedgehog tends to become glued to a certain outcome and is rather closed towards any dissenting opinion.
It turns out that foxes have a much better forecasting record, but the hedgehogs are more popular as television guests and draw larger audiences to their blogs. That should not surprise us. Most viewers or readers are looking for reassurance of what they believe already, rather than for the multifaceted picture of uncertainty that foxes usually deliver. The flexibility of the fox type is easily seen as a lack of confidence. His weighing of odds looks like a kind of groping in the dark. The uncertain viewer or reader is easily drawn towards the perceived certainty of the fixed belief of a hedgehog, even if that hedgehog turns out to be wrong 60% of the time.
My approach has always been fox style. I don’t really know where the market will go next month or next year, but I do weigh the odds of various outcomes and try to make an educated guess based on some cycles and indicators. I always remain aware how belief into cycles and indicators can also deceive us. In fact, less than half of my research is spent on studying how my cycles and indicators WORK. I spend slightly more time on studying how my cycles and indicators FAIL. That’s how I can be prepared for their failing, as they will inevitably do quite frequently. I think that is what gives foxes a better forecasting record in the end: they are more prepared to be wrong.
I once asked an old investor what his advice would be if he had to give it in one sentence, and his answer was: “You can not afford to be a bull or a bear.” He was of course just saying: don’t be a hedgehog, don’t allow yourself to *BE* a bull or bear based on any market theory, cycle or indicator… My experience with the lunar cycles is that they can help me to stay more in this “neutral zone”. Every two weeks the lunar cycle shifts between red and green period, forcing me to look at the other side of the market coin. That makes it more difficult to become “married” to the bull or bear side.
Are you a fox or a hedgehog? When was the last time you changed your mind about the direction of the market?
US markets have basically gone sideways since mid February. Is this a distribution top before a big drop? Or just a market pause before another surge higher? Let’s try to weigh the odds. Here is the current chart for S&P 500 (click for larger image):
We have started a lunar green period last week, and markets have responded with a nice rally already. For the short term we see my Earl indicator at an oversold bottom and turning up. This means the stage is set for another push higher this week, but the market will have to make it above the overhead resistance around 1880. If that hurdle is cleared then we see upside targets of ~1920 and ~2000 for the S&P 500. On the other hand, the slower Earl2 is hesitating and in the MoM indicator we see a bearish divergence. This means that any surge to new highs is likely to be short lived. A late March or early April peak would nicely line up all my indicators for a bigger drop this summer. When the current rally ends, a drop to major support just below 1700 could be next. If we do get the surge above 1900, then a drop back below 1700 will actually become more likely. We will examine that scenario in next week’s outlook, just before we start the next lunar red period.