Instincts vs. Market Timing Strategy
04/01/2015 6:00 am EST
Frank Kollar, of Fibtimer.com, highlights the human being’s ability to act instinctually and tendency to avoid risk and pain at all costs and how both of these traits—while practical in the physical world—are likely to cause poor decisions and loss of capital in the financial world.
Humans are born with basic instincts for survival. They need to protect themselves at all costs.
Certain critical instincts are inborn, such as hunger, self-survival, etc. But humans are complex creatures. We also have learned instincts, habitual ways of behaving that are so automatic and unconscious that they seem as if they are part of our very fabric.
Acting without Thinking Logically
For example, as you drive in traffic, you instinctively slow down or change lanes when the car in front of you seems to be driving erratically.
You may have noticed that many drivers will make the lane change to avoid slowing down and will even speed up to pass to take advantage of everyone else slowing down.
People react instinctively. Some act without thinking logically about their options, without taking steps to avoid possible danger. They often tend to make poor decisions.
Behavioral economists have demonstrated that people also make automatic, unconscious decisions when trading the markets.
"Only over time are substantial profits realized and only by those market timers who stay the course."
Most people are extremely risk averse. They enjoy the pleasure of a sure win, even a small one, but try to avoid the pain of losses at all costs. Yet there is no logical reason to show such an asymmetry regarding their decision making.
Investors also sell their winning trades prematurely so they can lock in their profits.
These unconscious and automatic decisions reflect a strong and universal human desire to avoid risk.
At FibTimer, all of our strategies are non-discretionary. Emotions do not play a part in our buy or sell decisions. Our strategies offer disciplined execution of non-emotional buy and sell signals.
The reason for following any timing strategy is to remove yourself from making emotional trades. To remove yourself from the herd, which is often headed in the wrong direction.
Towards the nearest cliff.
Playing It Safe
As humans socially evolved, they learned to protect their survival by playing it safe.
Playing it safe may be prudent for very long-term investors, but for shorter-term investors...those who are unhappy with the losses incurred during numerous inevitable downtrends and who wish to avoid those losses or to capitalize on the downtrends, fear of risk and uncertainty is an impediment to success.
It is necessary to identify this need for safety and security and reprogram yourself to work around it.
NEXT PAGE: Reprogramming Yourself|pagebreak|
Following the Masses
A common illustration of risk aversion happens when market participants follow the masses, as if they are wild animals banding together as a herd for protection.
They look toward others for direction, regardless of the consequences.
During a typical market correction, investors increase their selling the lower the market goes, with huge numbers of them selling near the bottom. The same thing happens in every decline.
As more and more people see prices drop, more and more participants sell. It is scary to see your investment values plummet.
"You must reprogram yourself to think outside the box." Is the news going to get worse? Will the prices reach even lower lows?
Most people are afraid of pain. They are afraid that the price may go even lower and they sell because they don't want to lose even more money.
Of course, not all investors will sell. Some will become so panicked that they will be afraid to acknowledge their losses and want to leave them on paper, hoping that the prices will return to previous levels in the coming weeks. During a bear market, this can be an even worse decision.
The masses try to avoid risk and pain, and by doing so, they tend to behave automatically. Repeating the same actions time after time.
Devoid of Emotions
Experienced market timers, in contrast, react more decisively.
They carefully follow a trading strategy that is completely devoid of emotions. They follow through on buy and sell signals with absolute precision.
They know that any one or more buy or sell signals may be wrong, but they realize that to trade profitably they must learn to trust their timing strategy and act on it. Only over time are substantial profits realized and only by those market timers who stay the course.
Think Outside the Box
If you want to be a winning market timer, you must learn to identify your need to follow the masses and teach yourself to avoid doing what your need for security compels you to do.
You must reprogram yourself to think outside the box. Rather than follow the masses, you must follow your timing strategy, which may be contrary to what most people would do.
Over time, and with extensive experience, you will develop the skills that will allow you to trade decisively.
Once you have reprogrammed your behaviors, you will not be tempted to follow the masses, but will instead recognize these feelings for what they are. Instincts for survival—which may work in the physical world—are likely to cause poor decisions and loss of capital in the financial world.
Rather than following the masses, you must learn to follow a timing plan, which is not affected by the emotions of the masses.
The more decisively you can follow the timing strategy, the more profits you'll realize.
By Frank Kollar, Editor, Fibtimer.com