Friday, April 16, 2010

Here We Go Again

Once again, we see the word "unexpectedly" being used in conjunction with a monthly move in consumer sentiment/housing/jobs reports.

I'm not sure what it would take to banish this word as it pertains to short term variance in noise-laden indexes. The article features this nugget re: Consumer Sentiment: "Economists surveyed by Bloomberg News had predicted the index would rise to 75 this April (preliminary)from 73.6 in March (final). The Index was at 73.6 in February, 74.4 in January, and 72.5 in December."

In order for something to be unexpected, there needs to be a sufficient degree of expectation.

Is that warranted for the monthly number on consumer sentiment?

You might as well argue how many Angels on the Head of a Pin or How many licks to get to the center of a Tootsie Pop
Statistical navel-gazing of this sort isn't merely silly as I mentioned here, it's counterproductive. It draws people into a pattern-seeking mode and into a destructively short-term focus that causes bad decisions.

Do yourself a favor. Resist it.

-Dr. Frank

Friday, April 09, 2010

Investing and Trading Psychology Condensed to 31 Precepts

Over the years I have created and collected the following pithy "precepts." These precepts are trading and investing guidelines that give a compass heading to trading integrity.

I offer them to you in their raw form. Some may make sense, others not. Please feel free to question, challenge, refine and edit with your responses.

  1. We are who we are and we start from where we start
  2. Each of us brings unique strengths to the markets
  3. Every morning we agree to play as delighted beginners
  4. Reality Pays. The more our minds model the market, the more in synch we get
  5. We build on our strengths and manage everything else.
  6. The outcome we have is the outcome we want
  7. If what you are doing isn’t working over and over again, re-examine your internal models
  8. Our internal process is more important than anything else because it drives everything else
  9. You have the resources to improve your mental trading game. Coaching just helps find them
  10. We begin our trading practice slowly and build it with flow and grace
  11. Lean into fear. Fear is a primary cause of failure
  12. If you are frustrated with the markets, that means they aren’t following the internal model you have projected on them
  13. We increase the level of our awareness rather than the intensity of trading
  14. As we expand our awareness, our interventions will happen sooner and be more creative and effective
  15. We respect ourselves and celebrate our profits no matter how large
  16. If we can experience a new behavior for a moment, we can experience it for a minute, an hour, a week, a year.
  17. Change happens when we experience a new behavior that is aligned with who we are, feels emotionally satisfying in the moment and takes us to where we want to go
  18. Avoidance is buying pain on credit with interest
  19. If self-criticism made us trade better we would all be rich
  20. We allow the markets to breathe through us
  21. The markets are messy, our information is imperfect, our systems will fail and we can still make money
  22. All trading systems are successful in some markets, all trading systems will eventually fail in all markets
  23. The markets don’t care about you or your position
  24. We seek the practice rather than the result
  25. Learn about yourself with the delight of an anthropologist finding a lost tribe
  26. We make internal maps of the market, but our maps are always distorted
  27. Our negative responses are created by our maps, not the market
  28. By changing our map, we change how we respond to the markets
  29. All our trading errors have an ultimate positive purpose or intention
  30. There is no “failure” just feedback
  31. You have all the resources you need, although some may be out of your awareness

Market Beer Goggles: Part II, Ethanol Stocks

(For Part 1: Click Here)

Market Beer Goggles: Part II, Ethanol Stocks

Three of the bigger players in Ethanol were VeraSun Energy Corp (VSUNQ), Aventine Renewable Energy Holdings (AVRNQ), and Pacific Ethanol (PEIX).

It is difficult to locate good charts of VeraSun and Aventine because both have declared Chapter 11 bankruptcy. Pacific Ethanol is technically solvent, but had its four operating subsidiaries file Chapter 11 petitions. Excellent summaries of what happened can be found here and here.

Let's take a look at a chart of PEIX. You will notice that in the week of May 9th, 2005, PEIX was at $10.60/share. In one short year, during the Beer Goggles Stage of acute intoxication and amorousness, it shot up to $42/share in the week of May 8th, 2006 (more than a 300% return). By the following year (May 7th, 2007), Pacific Ethanol was down to $15.39/share. A look at the volume (at the bottom of the chart) shows that the heaviest buying was on the way to the peak while PEIX was in the 30s. The comparative lack of volume on the way back down to 15 tells you that... a lot of poor people got stuck holding PEIX. And if that $15 price seemed to be "too low to sell". Consider this; by March of 2009 your $15 would be worth 23 cents.

What happened? Why did people break out the beer goggles and leer at VeraSun, Aventine, and Pacific Ethanol? What were they drinking? (My bet is tequila). In fact, several social/emotional factors were in play, danger signs for those who stayed sober enough to recognize them.

It Was the Next Big Thing: Investors are always looking for the "next big thing". The prospect of discovering the next Apple Computer while it's still being run out of a garage is one of the most enduring investing fantasies. Part of it is rooted in the almost universal desire to A) Get rich, and B) Not have to work for it. (This is the entire basis for the massive Lottery business). A new fuel that can support our energy needs and be grown in your back yard is indeed a compelling story, one that captures the imagination. It almost seemed too good to be true.

It Made People Feel Good: In addition to being a great story, the thought of ethanol appeals to our moral/patriotic sides. Regardless of what you think of the state of Anthropogenic Global Warming research, we all want a greener Earth. Only Bond Villains (and possibly a subset of hard core Raider fans) are evil enough want to choke the life out of the planet. To support a plausible, if perhaps specious case, against carbon-unfriendly fuels is only natural. Plus energy independence (or at the very least independence from people who hate us e.g., Hugo Chavez, Mahmoud Ahmadinejad, Saudi Wahhabists) are things most of us are actively looking to support.

Non-Investors Loved It: Ethanol was one of those rare investments that had people talking who knew nothing about investing. At, George Keeley, (my local) when I would tell people what I do, their eyes would light up - men and women alike; "Ooh! Tell me, what do you think of Ethanol stocks! Are they a good buy?" and "Do you have any stock tips? What do you think of ethanol?" As Bernard Baruch famously, if apochrophally, said before the Great Crash of 1929, "When the shoe shine boy starts giving you stock tips, it's time to get out of the market." In fact, non-investors chatting up stocks is one of the most tangible and reliable indicators that hype has eclipsed reality.

In the midst of all these danger signs came the greatest catalyst of all; the stocks took off. The cycle of hype > price gain > hype > price gain was a self-perpetuating motion machine.

People were as figuratively "drunk on ethanol" as if they were literally drunk on ethanol. That's why when we find ourselves "hooked on a feelin'" and "high on believin'", we need to order a cup of coffee, talk to that buzz-kill friend (or financial professional) to give us an alternative opinion and bring us back to reality.
There were/are points in favor of investing in Ethanol stocks. And our point here is not to put down companies or industries. There were; however, some powerful arguments against it:
  • The Brazil "success story" is an apple and we're an orange. Ethanol works better in Brazil because they make it from sugarcane, a much more efficient source. Also, Brazil has more available farmland and cheaper labor costs than we do. The US does not have these advantages.

  • It's corrosive. Ethanol can't be transported via traditional pipelines, as can oil or gas. It has to be shipped in trucks and trains with specially lined containers. Some claim this can be rectified in the US. At this point; however, it hasn't.

  • In the case of Pacific Ethanol, as noted in this article, California is "too far from the corn". In order to keep costs down, you want the corn supply close to the ethanol plant, 50 miles at most. The Golden State is a long way from the Hawkeye State.
Did people hear these arguments, (and many others) against these stocks before they stampeded in? Did they give full weight to the risk of investing in ethanol or merely the rewards?
Some people point to Bill Gates's investing in PEIX as evidence that it was a sound bet. But did those people bother to factor in the opinion of Warren Buffet (an actual investing professional), when he said this below:
"Charlie Munger and I do not know enough about the business to evaluate it. It depends on government policies and a lot of other variables we're not good at predicting. It's also a very hot area for investors right now, and we don't like looking at things that are hot and easy to raise money for. Generally speaking, agricultural processing businesses have not earned high returns on tangible capital. Ethanol could prove an exception, but I'm not sure how you gain a competitive advantage with any particular ethanol plant."

No. Probably not. When you're dancing with the lampshade on your head, the world - and all the people in it - look beautiful and bright. You don't want someone harshing your gig. That's why it is so utterly important that we invite some wet blanket, Johnny No-Fun to do just that.

Which brings us to MarketPsych Maxim that we drive home to our clients; Never commit money to a stock until you have heard (and digested) the best arguments against it.

To be fair to ethanol stocks (who are still in business), they have rebounded since their lows. PEIX has gone from under a quarter a share up to as high as $2.75/share ($1.38/share as of this post). Here's an article that makes a case for the comeback. But that is cold comfort to the beer goggling investors who, when the hangover set in and their bleary eyes fluttered open, found that their investment that looked so hot the night before looked anything but in the clear light of day.
Beware the Market Beer Goggles. Know the warning signs. Hear the best case against your case. And when you're feeling really, really excited about a stock, for goodness sake, order a club soda.
Happy Investing.

-Dr. Frank


MarketPsych is the original Investing Psychology Consulting Firm. We have been doing talks, keynotes, trainings, workshops, coaching and consulting in the field since 2002. Our clients include institutions and individuals in all areas of the financial community. Contact us at for more information on how we can help you.