Sunday, November 25, 2012

Slugs and Sugar: Gender Effects on Investing and Nokia


Slugs and snails
And puppy-dogs' tails,
That's what little boys are made of.
Sugar and spice
And everything nice,
That's what little girls are made of.
- Nineteenth century English nursery rhyme.
________________________________________________

'Honey, what happened to our retirement savings?'

If you're a man, your partner may have asked you this at some point in the past few years. 

'Hmmm, I'm not sure what you mean?' you may evasively answer.  (The truth is, you're very aware that you invested too much in that awesome small cap tech stock.  Sure it's down 50% since you bought in, but it is such a GREAT story, it HAS to work out.)

She persists, 'I mean, how come the account has less money than last year?  The market was up this year.'

Now if you're like most men, you want to please your wife (and yourself).  And you probably believe what you say next:  'Um, well, I invested in CyberNanoTech and they had a bit of a setback this year because of the FDA, but their long term prospects are amazing, everyone says so, so I’m holding tight.'

'What is CyberMamoSpec?'

'Well, Joey at the Club was saying they have this world changing….'  

'Honey, what does Joey know about investing, isn’t he an orthodontist?'

This is why men need wives, to pop their unreality bubbles.

It's at this point in the conversation that his wife may pick up the phone to call a financial advisor.   And if all goes according to her plan, which is likely, their financial relationship dynamics will become the domain of a financial advisor, which is another story (and one I often speak to advisors about).

The above parable is an amalgam of stories I've heard from most of my male friends.  As investing sterotypes go, women tend to be more prudent and men the risk-takers.  As we'll see in this letter, the type of risk-taking men do often doesn't work out well, especially when the men involved are amateur investors (which, despite their winning personal assessments, most men are). 

After we review of the mistakes that amateur investor men (and women) predominantly make, we’ll look at the research behind that.  Then we'll look at evidence of the role of women in keeping public debt levels low, but also in driving firm valuations lower.  We also consider a report on the sensitivity of female risk taking to the menstrual cycle.  In conclusion we'll integrate the various findings to see if there are any lessons for Wall Street and our society.

Gender and Personality

Note:  if you haven't already, please take one of our free online personality tests before reading on.  You'll be in good company, over 20,000 people have taken at least one of our tests. 

In our Trader Personality Test results we see that women traders do not differ substantially from men in terms of performance and volatility.  Professional traders – both men and women – must stay disciplined and with proper risk management in order to survive in the business.  Good discipline is a prerequisite to successful trading.

Among people who have taken our Investor's Personality Test, we see a different phenomenon – women vastly outperforming men.  Our Trader's and Investor’s Personality Tests are differentiated by the average length of holding time for positions – in the case of investors, 3 months or longer.  For investors we see that gender is the most powerful explanatory variable (after experience) in dictating market returns.

In this study we examined investors who took our Investor's Personality Test from 2005-2010.  After removing those with less than five years experience, from countries without developed financial markets, those who gave repetitive answers, and those beyond the age bounds 25-80 years old we had 2,600 results left.  Follow this link to take the test if you haven’t already.  Nineteen percent (19%) of the final sample were women.   All test-takers had reported their  largest historical drawdown and their past five years investing returns.

Women reported much higher five year returns than men.  Further, women reported much lower average lifetime drawdowns.  Women risked less than men yet were more profitable according to these results.
In order to understand how women’s profits were so much greater, we looked at gender differences in the individual bias questions in our tests.  In general women reported being more self-disciplined, grounded, and emotionally aware.

Men were more likely to report:
1.       Vengeance:  Taking revenge on others. 
2.       Overconfidence:  A higher rating of their own investing skills (unjustified by reported returns).
3.       Cutting Winners Short:  Selling winning investments quickly (a.k.a., seeking pride),
4.       Feeling Relaxed:  Men report experiencing less stress than women.

When you think about it, these responses could be a bit problematic.  Bringing ego into investing by taking revenge on markets or other traders or seeking pride through successful trading leads is far from the rational analysis preferred by successful investors.

To be clear about the limitations of the simple study we did, there is self-report bias in our sample, in which people rate themselves based on their opinions.  Based on cultural and perhaps competitive pressures, men are more likely to exaggerate their risk tolerance.  This study shows that women do take less investment risk than men.  At the same time women also under-report their risk tolerance.  To look into others' research on gender-specific investing behavior, we turn to a classic study.

Reseacher's Corner:  Boys Will Be Boys

Our performance results – showing men outperforming women - are congruent with those reported by Brad Barber and Terry Odean at the University of California at Berkeley.   In a study of 35,000 brokerage accounts between 1991 and 1997.  The authors found that women had 45% less portfolio turnover and 1.4% greater average annual returns versus male investors.   To be clear, both men and women underperformed the stock index, but men underperformed more.

John Coates, whose work we profiled last week, cites evidence that women change their risk taking to be more like that of men when given testosterone.  Coates speculates that bringing more women onto the trading floor may improve returns:

[T]here are grounds for thinking that women may be less ‘hormonally reactive’ when it comes to financial risk-taking. For example, women have only 5–10% of the circulating levels of testosterone of men, and they have not been exposed to the same organizing effects of pre-natal androgens. Furthermore, some studies have found that women's HPA axes are less reactive to stressors stemming from a competitive situation (Stroud et al. 2002). Their greater presence in the ranks of money managers may therefore help dampen hormonal swings in the market.  (Coates, 2010)

In a blog post, Brad Barber (co-author of the study above) indicates that women tend to be more focused on planning and wealth preservation while men are more competitive and focused on growing capital.
As in the above, there are general conclusions to be drawn from research about female traders and investors, but as we dive deeper into the specifics of how men and women are affected by their biology and how they perform in leadership groups, the plot thickens.

Women on Wall Street

The question remains, if women are such good long-term financial decision makers, why are so few women in top investment positions?  The answer to this question is not clear, although hypotheses are many.  Some have hypothesized that there are some additional factors at play among the very elite in the field (as Larry Summers famously did regarding women and math, precipitating his removal from the presidency of Harvard).  Others believe that many women don’t find the political game of rising to the top of an investment firm as rewarding as men typically do.  While ego and pride appear to disproportionately hurt men’s investment performance, perhaps these same factors help men succeed in competitive business environments (where their performance cannot easily be judged quantitatively). 

While there are no easy answers for Wall Street leadership positions, we do see that greater female presence in government leadership correlates with the financial health of a country.

Women in Government

Given the above findings – that men enjoy revenge (and it correlates with lower investment returns), that men think they are better investors than they actually are, and that men are more likely to take catastrophic financial risks – it would make sense that parliaments with a higher proportion of men would experience more gridlock, higher debt, and a worse investment track record.

In order to study this hypothesis, I first selected 18 long-term developed countries including western European democracies, the USA, Canada, Australia, and Japan.


(Image courtesy of our Chief Data Scientist, Aleksander Fafula, Ph.D.)

Using data on the percentage of parliamentarians who are women from this list, I selected out 18 Western democracies.  Then using list of national public debt to GDP from Wikipedia, I ran a simple correlation.  It turns out that the more women in parliament, the lower the national debt to GDP ratio (R=0.7).  When the two outliers are removed (e.g., Japan), the correlation remains 0.7.  Perhaps men are taking more short term financial risks, while women are perhaps modulating the risk taking and keeping resources secure for future generations.

It wouldn’t surprise me if the male propensity to ego-involvement, seeking pride, feeling less stress despite high risks, testosterone-driven competition, and greater risk taking are behind the U.S. fiscal cliff debacle.  Perhaps the solution is to bring more women into the U.S. Congress.  But that said, I’m no fan of mandates, and my inclination to avoid mandates is backed up by global evidence from corporate governance ratios.

Mandate Femininity?

Is the answer to men's poor performance to mandate more women in government and investment leadership positions?  The preliminary evidence indicates that mandates (at least for Boards of Directors) are a bad idea.  Studies on Norwegian firms, U.S. firms, and Indonesian firms found that increased female representation on the board of directors decreased long term company value.

Another interesting aspect of women's role in investing decisions regards unstable risk taking.  The menstrual cycle appears to change how women deal with risky situations.  While men may be more hormonally reactive to specific external events and competitive pressures, women have an internal hormonal cycle that significantly alters their risk-taking and emotional state.  Phases of the menstrual cycle correlate with different risk taking in this study and this one but not this one.  The differences that are found may be traced to both the phase of the menstrual cycle and the resultant hormone-modulated neural activity in the brain.
So while mandating more women in certain positions seems like a good idea, there is a lot we don't understand.

More Sugar?

So far we've seen that women have higher overall investment returns and take lower overall risk.  The higher performance of women versus men appears to be due to enhanced emotional self-awareness and less ego involvement in investing  (less cutting winner short - seeking pride – and less revenge-trading).   Further, we see that Western countries with more women in parliaments have lower public debt to GDP and appear to think longer term about the nation's finances.  But the evidence in favor of more women in financial industry leadership is not conclusive.

We also see that bringing more women into corporate governance reduces firm returns (a global phenomenon).  Additionally, women are more susceptible to the effects of hormonal shifts during their menstrual cycle – those endogenous hormonal shifts significantly alter women’s risk preferences and risk taking.  Given all of the above information, when asked if women should be more represented in Wall Street leadership positions, the conclusion has to be an anti-climactic cop-out … it's not clear.

Sentiment Trading

Trading recap from last weekOur one-week buy on DryShips (DRYS) was up 1%, and the one-week short on InterOil Corp (IOC) also made money, as that stock was down 6.5%.  Our medium term picks of RIMM and KOL (Coal industry) are moving along, with RIMM now up more than 20% from our recommendation, but KOL is still floundering.

Week ahead:  We have two short term calls:  A short on Nokia (NOK) for the next week. Nokia has run up far, fast, but it appears the short term exuberance has run ahead of itself.  We’re seeing a one week buy on Diamond Foods (DMND) which had a stock price plummet and is now buffeted by extreme negativity in social media.

While short-term strategies are the easiest to find with sentiment data, we’d really prefer to offer longer term strategies, and we think we’ve found some.  We’re putting them online soon, and I’ll be discussing more macro calls (and fewer short term ones) in later newsletters.

Happy Investing!
Richard

Saturday, November 17, 2012

Traders Who Take Sex Hormones and the Impact of Investor Anger on Prices


"If taking female hormones actually helped you do your job, they would simply hire women here...But they don't. They don't think women are aggressive enough."
~ New York Post, citing an SAC employee and reprinted here.

A couple years ago I began coaching a trader with a hormonal problem.

On first meeting him I wouldn’t have noticed that anything was amiss.  As he described his history of trading – his glory days over the past decade -- his voice rose to a boom and he paced the room animatedly.  When I tried to cut in, he wouldn’t have it.  He was dominating the conversation…until he began to describe the present day, and then he deflated back into his chair.

He told me, “When I trade at my best I’m aggressive and decisive.  Ready for whatever the market throws at me.”

“And how have you been trading lately?” I asked.

“I’m none of those.  I’m indecisive and cautious.  I’m just sort of limp when I need to be strong and fast.  And I just keep losing money. You know, it’s as if I’ve lost my mojo.”

Trader Mojo

Mojo
.  Immortalized for a generation by Austin Powers, mojo is manliness.  Without mojo there is no vigor, no sex drive, no aggressiveness.  Losing mojo is like losing the animating man-force.  When Austin Powers lost his mojo, he spent most of a movie trying to get it back.



The trader I was working with had symptoms of low mojo, and they mirror the symptoms of low testosterone – less aggressiveness, indecisiveness, cautiousness.  And there were a number of recent events in his life that are known to lower testosterone: a new baby with sleep disruption, co-sleeping with his baby at night, no longer exercising, and even becoming a vegetarian.

Was low testosterone turning this former shark into a wet noodle?

This week’s letter will discuss the role of testosterone in financial decision making, particularly in short-term trading.  Along with the testosterone theme, we examine Anger as a (inverse) predictive signal for future market prices.  In next week’s letter we’ll examine the role of gender and gender-specific hormones in financial decision making and national economic policy (yes, it appears the fiscal cliff is the fault of men, but more on that next week).


‘Roid Rage


From sensational stories of “roid rage” among body-builders in the 1980s to this fascinating podcast produced by This American Life, which discusses the role of testosterone in changing everyday feelings and behavior, testosterone has been long part of public discourse.

Testosterone level are fixed over the lives of men.  In fact, they rise and fall in response to life events, altering our moods and behavior in the process.  Testosterone levels decline an average of 1% per year in men after the age of 30.  But even more dramatic, baseline testosterone falls a median of 30% after men have young children.  It falls further when men sleep on the same surface/bed as their children (co-sleeping) and when they spend more time parenting.  According to a study described here, sleep loss also reduces men’s testosterone levels.  As a result, new fathers over the age of 30 are likely to experience plummeting testosterone levels, just when they need extra assertiveness and vigor to advance their careers.

Body-builders have long had a sub-culture oriented around testosterone and androgenic (virilizing) hormone use.  For all competitive athletes, an extra 1% performance boost from testosterone can be the difference between first place and mediocrity -- just ask Lance Armstrong, Floyd Landis, or the East German Olympic team.  Here is an image outlining the effects of testosterone on the body Yet testosterone cannot be easily replaced with supplements or “boosts” without significant side effects when taken over physiological norms, as described in this Mayo Clinic article.  Men who take testosterone supplements may not feel the mental and physical benefits are a worthy trade-off for enlarged breasts and shrunken testicles.

Beyond athletics, testosterone does significantly influence financial decision making as well.  John Coates, Ph.D. has collected evidence that testosterone level is not only correlated with, but is also predictive of, improved financial decision making among ultra-short term traders.

Investor Anger and Market Returns
Before we jump into examining the effects of testosterone on trader behavior, let’s look at an emotion that is often correlated with testosterone usage:  self-righteous anger

You’ve probably noticed that a high proportion of comments posted on social media sites are, well, impolite.  In fact, we’ve found enough naked hostility and open contempt in financial social media commentary to begin quantifying both Anger and Insults.  Our goal was to see if such combative comments were correlated with future stock returns in the equities about which such contempt was expressed. 

There are a few compelling examples of anger, like this graph of Netflix (NFLX) which broadly shows rising anger correlated with the share price decline, where Anger is the green line and the candlesticks represent NFLX stock price. 



But the question remains, is rising anger also predictive of a falling stock price?

To answer that question, we performed an unscientific study in which we looked at 40 ETFs tracking the largest indexes, sectors, and industries in North America with high Buzz (lots of chatter) in financial social media over the past 14 years (1998-2012).  We then sorted those ETFs by the percentage of that chatter that was Angry in the Thomson Reuters MarketPsych Indices.  The past 24 hours of Anger aggregated to 30 minutes before the close today (t) was matched to the percent return from today’s Close to tomorrow’s Close (t+1).  For each Quintile of Angry days - Angriest 20% of days is on top and least Angry 20% is on the bottom – we averaged the one-day return of that ETF over the following day. The sample included data from 1998-2012 but largely centered on 2008-2012 due to a higher number of ETFs being available for analysis over that period.

One Day Forward ETF Return
Quintiles
-0.01%
Highest Anger
-0.02%
0.03%
Middle Quintile
0.06%
0.10%
Lowest Anger

Assuming that you are short the ETFs with high anger and long the ones with low anger, then you may have an interesting strategy.  0.10% (10 bps) per day doesn’t sounds like much, but over a year that’s a 25% return (excluding transaction costs).

Now keep in mind that there are a number of problems with this 5 minute study:  no transaction costs were included, no portfolio construction was done, it included ETF’s depending on the overall Buzz level (a minimum of 2,000), it is not cross-sectional, there are it is not controlled for price momentum or other condition, etc...

Despite those caveats, it makes one wonder.  Does Anger predictably affect investors’ risk tolerance such that they will not take risk (invest) going forward, and thus prices are more likely to drop until their anger is worked out?  It’s worth investigating…

Anger isn’t directly related to testosterone, except in that the tendency to take revenge is in fact modulated by testosterone level.  And it’s not just revenge that increases with testosterone level – many other behaviors are also impacted by testosterone.

Effects of Testosterone On Behavior
John Coates’ testosterone research on traders is summarized in this terrific 2010 academic review and in this fascinating 2012 book: “The Hour Between Dog and Wolf.”  Coates holds a PhD in economics and a PhD in neuroscience. But more importantly, he also worked as a Wall Street trader for many years.  Coates began learning about the endocrine system while still on Wall Street, and in his book he lays out an argument that the boom-bust cycle in financial markets may be magnified by hormones and their effect on behavior.

Endocrinologists have found that many environmental influences alter human hormone levels and behavior.  For example, before any competition testosterone levels rise.  Then after the event the testosterone level of the winner rises further and that of the loser drops.  The winner moves on to the next competition with a now-higher baseline testosterone level, is likely to act more aggressively, and is more likely to win.  Interestingly, Coates and his colleagues report that, “one trader, who enjoyed a 5-day winning streak during which he made over twice his daily average P&L, experienced a 75 per cent increase in mean daily testosterone.”

High testosterone levels have been found by researchers to increase cognitive skills such as vigilance, scanning, speed of reactions, and search persistence.  And high testosterone improves focus of visual attention while decreasing distractability.  Further, studies some studies have found that testosterone level is correlated with risky behavior, sensation seeking, and vengeful behavior.  In some other studies, administered testosterone increases confidence and fearlessness in the face of novelty.

Based on the evidence, it would make sense that testosterone levels predict performance in rapid-fire trading.
Researcher’s Corner:  John Coates
In one study Coates sampled testosterone from 17 young male traders twice a day over a period of eight business days.  The results were impressive:  “[O]n days of high morning testosterone, the traders returned an afternoon profit … that was almost a full standard deviation higher than on ‘low-testosterone’ days. Interestingly, this relationship was even stronger among experienced traders …, i.e. those who had traded for longer than 2 years, suggesting that testosterone, at moderate levels, was not having its effect by encouraging overly risky behaviour but was instead optimizing performance, at least with respect to high-frequency trading.”  See this visualization of the difference between high and low testosterone trader performance.

In another study Coates examined the 2D:4D ratios in 44 traders.  The 2D:4D ratio is the length of the second digit (index finger) divided by the length of the fourth digit (ring finger).  See how it is measured below:


Prenatal exposure to testosterone influences both ring finger length and also brain structures related to risk-taking and behavior.  Coates and his colleagues found that the 2D:4D ratio “predicted both the traders’ P&Ls over a 20-month period and the number of years they had survived in the business. It also predicted, in line with the organizational/activational model, the sensitivity of the trading performance of the original 14 traders [who participated in the first study cited] to increases in circulating testosterone: the lower the trader's 2D:4D, the more money he made when his testosterone levels rose.”

Having high testosterone levels or a high D2:D4 ratio comes with some baggage, as the ratio is also correlated with infidelity.  Case in point:

OK, OK, that picture is doctored (from here).  But still....

Coates summarizes his research findings as, “[O]ur results suggest that higher levels of circulating testosterone predict short-term profitability and higher levels of pre-natal testosterone predict long-term profitability, at least in the segment of the market inhabited by high-frequency traders.”  As Coates notes, these results are valid for short term traders, but not necessarily for longer-term analysts or investors. 

It’s not clear that long-lasting elevations in testosterone, such as during a winning streak are good for traders.  It’s likely that traders, like dominant animals in the wild, will become overextended as they win.  Male animals who defeat rivals and thus control more territory experience a downside to their success.  Ultimately these alpha males suffer more injuries and have a shorter overall life-span.  Live by the sword, die by the sword.

It is quite possible that traders who are successful serially and who have higher testosterone levels will begin to feel fearless and become sloppy with their risk management.  Testosterone facilitates sensitivity to dopamine secretion in the brain’s reward system – specifically in the nucleus accumbens.  As a result, higher testosterone levels are likely to lead to increased risk taking – pushing the envelope.  That is good until it goes too far and a major loss ensues.  This is the contribution of testosterone to the boom-bust cycle that John Coates hypothesizes.

DHEA and HGH
Because testosterone itself provokes a range of adverse effects when taken above physiologic norms, researchers have studied sex hormone precursors such as DHEA to see if supplementation with this substance will increase testosterone availability more naturally.  DHEA is a precursor of testosterone that was long thought to improve cognitive functioning and stress resistance.  Unfortunately for those seeking a testosterone-boosting short-cut, in fact studies have not borne out that there are any psychological benefits of DHEA (see this review and this study of military trainees).

The following image of the body’s manufacturing pathway from cholesterol to testosterone is from medicalinsider.com (here).  As you can see in the image, increasing testosterone by augmenting its precursors may also leads to higher levels of associated hormones such as Estrogen.



Most traders are probably not looking for increased estrogen.

Other hormones such as Human Growth Hormone (HGH), famously taken by many of Hollywood’s over-50 elite, do not increase testosterone levels.  And while HGH appears to have a number of beneficial effects on physique, mood, and well-being, the long-term effects of use are not yet clear.

As of yet there is no wonder-pill to increase trading or investment prowess.  Which brings us to natural remedies for keeping our bodies and hormonal systems healthy.

Boosting Your Mojo

When Dr. Evil drank a vial of Austin Powers’ mojo, he … (well, I won’t recommend you watch the entire clip, but you’ll get the idea in a few seconds). 

Like Dr. Evil and Austin Powers’ mojo, traders who take testosterone aren’t necessarily going to see benefits from the hormone.  There are significant side effects, and traders should speak with a physician is they suspect something is wrong.

In my work as a coach, I find that the best approaches for boosting testosterone in traders are natural means:
1.  Get a good night’s sleep (7-8.5 hours),
2.  Get regular and vigorous exercise,
3.  Eat
foods that raise testosterone,
4.  Don’t nap/sleep near your infant children,
5.  Exercise vigorously.  Exercise is even better for boosting testosterone when it is competitive and you win.  But beware when a favorite sports team loses, that loss will literally drop your testosterone levels further.

Here are tips for increasing testosterone naturally on the LiveStrong website.

Boosting Your Mojo
In our personality research, we see that women and men have similar performance as short-term traders, but in longer term investing, women have far better performance than men.  So while testosterone may benefit men in short-term trading, where decisions must be made rapidly and aggressively, for longer term strategic decision making it is unclear that testosterone offers an advantage.  In fact, in our personality data, we see that men are much more likely to make testosterone-fueled errors characteristic of “seeking pride” (selling winners too soon) and revenge investing to “get back” what the market took away.  These biases are unique to men and significantly erode their long-term investment performance.

Next week’s newsletter will look at gender differences between men and women in financial decision making, how the differences manifest, and how to improve our own gender-biased behavior.  The research may surprise you…

Hosuekeeping and Closing

We recently launched the Thomson Reuters MarketPsych Indices for monitoring market psychology for 30 currencies, 50 commodities, 120 countries, and 40 equity sectors and industries in social and news media.  In subsequent weeks we’re going to have interesting charts related to global macro sentiment trends as our new data is plugged into our internal visualization software.

In the next month we will be speaking in New York at Quant Invest and our Chief Data Scientist, Aleksander Fafula Ph.D., is speaking at Predictive Analytics World  in London.

We love to chat with our readers about their experience with psychology in the markets - we look forward to hearing from you!  We especially love interesting stories or your or others experiences.

We have speaking and training availability.  Please contact Derek Sweeney at the Sweeney Agency to book us: [email protected], +1-866-727-7555

Happy Investing!

Richard L. Peterson, M.D. and The MarketPsych Team



Saturday, November 03, 2012

Hurricane Psychology, Buying Pessimism (RIMM), and Finding Redemption


While forecasters predicted Hurricane Sandy would be the worst storm in New York history, many people did not prepare adequately. 

OK, to be perfectly honest, I did not prepare adequately.  In response to my New England-born wife’s question posed before the storm, “Shouldn’t we buy a generator?” My response, “Generator? Who needs a generator?” will probably rank as one of the more egregious on my Clueless-Man-Responses List,  just ahead of #6 “No, I know where I’m going, I don’t need a map,” and just behind #4 “Anniversary?  You mean today?”

In my (and my wife’s) quest to understand the Clueless-Man-Responses List and why it continues to be populated, I did a bit of research.  Turns out that due to a mental mechanism called the “projection bias,” people’s intellectual assessments of a danger (“worst storm ever”) conflict with their emotional experience (“I’m fine right now, those forecasters must be exaggerating.”)  In these scenarios, most people go with their gut – “It’ll be fine, it always is.”   As a result, there is inertia in their preparations.  

In fact, as I write this letter I am warm and cozy (and a tad humiliated) at my wife’s parents’ house in Maine.  A couple days without heat and power was enough to turn us into storm refugees.  Thank goodness for the kindness we’ve encountered since the storm.  One thing I was impressed by after the storm was the tremendous goodwill and comraderie of neighbors in affected communities.

Election Psychology

There is an 80% chance Obama will win next week’s election per the New York Times.  So what does the election mean for financial markets?  Uncertainty drives investors to the sidelines, creating pent-up demand.  As a result, we could see a relief rally in the week following the election. 

That said, the real political concern of markets is the fiscal cliff at the end of the year.  Once the cliff is resolved, probably earlier than expected, we could see a much more significant rally ensue late this year and into next.  American economic growth and the housing market have momentum behind the rebound.

In last week’s newsletter we looked at the rise and fall of a trader who bet against George Soros out of pride and ego.  The trader (Bob) resented that he was not a globally recognized top trader.  He lost everything in one trade, declared bankruptcy, and was on the verge of suicide at his lowest point. 

This week’s newsletter explores the psychology of redemption.  Bob followed a set of principles to pull his life back together that can be used by anyone in a slump or stuck in an emotional rut.  We also take a look at a company (RIMM) and an industry (Coal) in a rut, and we analyze how and why investor sentiment about these two may indicate a positive reversal is near.  


Recent Press

The Social Media Stock Pickers.”  Alexandra Stevenson.  Oct 22, 2012.  Financial Times.

Social Media Stock Pickers.” Oct 23, 2012.  Advisor.ca.

Advisers Must Understand Clients' Personalities.” Corie Russell.   Sep 19, 2012.  PlanAdviser.

Press about the launch of our Thomson Reuters MarketPsych Indices:


Michelle Price.  Oct 8, 2012.  Financial News.

Partial List of Past Press.




Bob Hitting Bottom
The word "forgive," according to the Chambers Dictionary of Etymology, comes from the Old English for-completely + giefan-GIVE.

Bob didn’t hit bottom in a dramatic fashion.  As he tells it, he looked in the mirror one morning, and he spied a foreclosure notice out of the corner of his eye.  He looked directly at himself in the mirror and thought, “Who is this guy I’m looking at? I don’t like him!  That’s it, I’m done.”  He thought of the jerk he had become, and he figured that suicide may be the best amends for his sins. Bob went for a walk that morning, pondering whether to end his life.  On the walk Bob bumped into an old trading buddy who had heard about his fall.   The buddy invited him to an Alcoholics Anonymous meeting that night. 

At the meeting Bob recounted his story and was amazed that many in the room could relate.  He had spiraled downward driven by forces and compulsions he was only dimly aware of, yet many in the room had parallel stories of self-destructive behavior.  Like others in the room, Bob had poisoned many of his relationships with ego-fueled ambition and narcissism.  Bob realized that his life wasn’t just about him.  And as he looked around the room, and listened to the stories of other alcoholics, he realized that he had hurt many good people. 

Bob went home that night made an inventory of everyone he had hurt.   He decided that suicide would be no use if he didn’t at least try to make amends to these people for the pain that he had caused them.

He first called his parents and apologized for virtually destroying the family business.  He explained his realization that he was alcoholic and out of control.  He apologized for past behavior and volunteered to work 80 hour weeks for his family for two years in exchange for room and board.   Eventually they let him come back to work in a minor capacity, but not without testing his sincerity.  

As in the quote that opens this section, in order to win redemption from a life of narcissism and petty resentments, one must give completely of himself.  After his fall, Bob spent two years working off his moral debts and maintaining his sobriety.  During this period he regained some social support and mental balance.  With the blessing of his family, he left the business to begin his new career in technology.  Bob started and grew his own technology company.  He has been sober for 15 years, and what’s more, he recently started a happy, healthy family of his own.

We’ll address what Bob did to get out of his rut later in the newsletter.  But first, we’ll look at the case of companies in a slump:  RIMM and Coal.

Redemption Investments?  RIMM, Nokia, and Coal

RIMM management has made a series of blunders that in any other industry besides smart phones would not be so quickly fatal.  But RIMM lost brand credibility and has fallen far behind.  Nonetheless, 10% of the global smart phone market is not a bad place to be if your customers are loyal individuals (or inert corporate clients).  Rumors of RIMM’s demise have been swirling for more than a year and intensified this summer.  But lo and behold, RIMM stock is rising from the ashes.  Is this a value-play or an honest-to-goodness redemption? 

Don’t expect RIMM to recapture its former glory.  There has been open dissention and a loss of shared passion.  See this open letter for details.  That said, the leaks appear to have turned positive.  These product development leaks show an impressive pipeline.  Given that expectations are the driver of risk taking among investors (“buy on the rumor”), we could see a continuing rally in RIMM shares until the new phones are released (“sell on the news”).

We have already seen increased Liking of RIMM by online investors.  The green line in the chart below quantifies the amount of Liking expressed about RIMM and RIMM products in the financial social media from Nov 2010 to Nov 2012.  Note that Liking has risen substantially off its lows.



We are also seeing that RIMM is re-emerging among its peers in overall Sentiment.  Note that Microsoft (MSFT) typically drags the floor in sentiment.  Apple (AAPL), which usually rides high in sentiment, had a serious sentiment decline this summer around its price peak, and it is now below Google and RIMM in overall sentiment value.  Meanwhile, Google surged in sentiment following its July 19th 2012 earnings report.



In the case of RIMM, a short-term redemption may finally be at hand.  But the safest way to be involved is to buy the rumor of redemption.  For companies, long term redemption is nearly impossible.  Remember Nokia (NOK)?  Amazingly, the one year Fear and price chart on Nokia looks incredibly similar to that of the Coal industry, below.

The coal industry has been down in the dumps lately due to falling Chinese demand and concerns about climate-related regulation.  “Sandy” is again focusing attention on the human consequences of greenhouse gas build-up, as this Bloomberg cover testifies.    There has been a recent price surge in Coal.  Whatever the cause, the long-term outlook for the coal industry is negative in the U.S.  In the image below there is a recent surge in Fear (green line) in the Coal-industry ETF (KOL) to multi-year highs as the U.S. election approaches, the stock prices hit new lows, and more utilities turn to natural gas.



I’m not endorsing a long-term coal investment.  But from a contrarian point of view, coal is certainly interesting.  And some U.S. stocks like BTU have good cash positions and are exporters.

Is “redemption” likely for the coal industry?  No.  Coal is a chief culprit for global warming and mercury in seafood, and it’s unlikely to become less regulated or more favored anytime soon.

Redemption is not easy for companies, and likewise it is not easy for individuals like Bob.  That said, as individuals we have more control over our individual destinies.

Investor Slumps
Just as with athletes, investors will eventually, and often repeatedly, experience slumps in performance.  On the psychological level slumps dent confidence, paralyze decision making, and impair risk assessment.  During a slump personal balance is lost, and impulsive risk-taking alternates with paralysis.  On the biological level, negative feelings are seared into the amygdala, changing how we remember, assess, and respond to future risks.  The long-term consequence of a deep slump is a kind of financial post-traumatic stress disorder (PTSD) in which our decisions about risk can become permanently distorted.  For someone like Bob, alcohol and cocaine numb the despair associated with a slump.  But these chemicals also biologically impair resilience mechanisms, resulting in a steep downward spiral of interrupted sleep, impulsive behavior, and an eventual blow-up.

Once in a slump, climbing out is not quick or easy.  There are two analogies applicable to investors in a performance dip, one from baseball and one from golf.  Ted Williams of baseball fame once said the key to great hitting is to wait for your pitch.  Baseball success is associated with a rapid assessment of the ball’s trajectory and a snap judgment of “yes” or “no.”  But unlike baseball, a golf ball waits for you to hit it.  As a result, golf is about deliberation, practice, and precision.  Tiger Woods took a year off professional golf to readjust his golf swing.  The key to getting out of a slump is to climb out one successful trade at a time – one perfect swing at one perfectly placed pitch – to rebuild confidence and motivation. 

Working out of a slump requires 1) accepting the slump for what it is, 2) focusing on what works in the current environment, 3) jettisoning what (and who) doesn’t help, 4) readjusting your perspective to one that supports profitability, and 5) waiting for YOUR PITCH.  Unfortunately for resentful investors, it is situations like this year – when markets rally on persistent gloom – that they are again traumatized.  As a result most investors have been missing out on a bull market.

So how do we stay flexible in today’s volatile markets?

Staying Flexible
Mental adaptability is the most significant trait behind investor success that we’ve identified in our online personality tests.  There is a method in the challenge of climbing out of a rut, and it is rooted in using your mental flexibility to ask good questions and try to see things differently than the status quo. 

If you’re in a slump now, get out a pen and paper and go through the following steps for yourself:
1.     Admit you are struggling.  It’s OK to struggle.  Everyone struggles at times -- it’s called life.  Write down what you are struggling with.
2.     Now look back at your biggest failures in the past.  How did you fare afterwards?  Odds are you rallied back.  That wasn’t an accident.  You were able to find the strength within and/or take advantage of help from others.  Can you identify what turned it around for you?  What did you do to speed up the comeback?
3.     Now think about today.  Where have you been getting bad advice, useless information, or suffering from negative influences
4.     Then look within yourself – which habits of yours are keeping you muddled:  Bad sleep habits?  Alcohol use?  Not exercising regularly?  Family or co-worker conflict?
5.     In your investing, figure out what is working for you or others in the current environment.  Write it down in detail.  Then look at what you are doing that isn’t working, and ask yourself, how can I do more of what is working and less of what is not?
6.     Now look at your current investments.  List objective factors about them.   Identify the investment convictions you hold and be clear about how your convictions could be proven wrong – price action is not the best proxy, but changes in fundamental conditions are.
7.     Feedback in investing should be around the process, and sticking to the process, not outcomes.  Make sure you evaluate your thesis on long-term, not short-term, outcomes.  And keep in mind that a bad economy does not necessarily mean negative asset returns.  Write down your process, and look for how it can be improved.

The guidelines above are not a silver bullet, but they should provide a solid start.

Next week we will explore how to read the indicators of when a company, country, or investment has what it takes to pull out of a slump…

Trading Recap

Trading recap from last week:  Buy on AMD was wrong, as AMD dropped about 1% from the week’s delayed open.  Short on Apple (AAPL) was correct, as AAPL dropped about 2.6% from the week’s delayed open.  Mild long on S&P 500 was wrong, with a 0.3% loss from the week’s open.

Week ahead:  We’re still seeing a mild buy on the S&P 500 this week, which may be due to pent up tension due to the upcoming election.  We’re also seeing a one-week short on Netflix (NFLX) due to lots of love following a good earnings report (overreaction), and a one-week short on Exelon (EXC) which despite a recent price drop, is seeing signs of denial among investors who continue to like the high dividend and low P/E ratio.  (See Disclaimer below).

Housekeeping and Closing

We recently launched the Thomson Reuters MarketPsych Indices for monitoring market psychology for 30 currencies, 50 commodities, 120 countries, and 40 equity sectors and industries in social and news media.

In the next month we will be speaking in New York at Quant Invest and our Chief Data Scientist, Aleksander Fafula Ph.D., is speaking at Predictive Analytics World  in London.
  
We have speaking and training availability.  Please contact Derek Sweeney at the Sweeney Agency to book us: [email protected], +1-866-727-7555.

We hope you found the letter this week interesting and useful!  We always love to hear your thoughts and suggestions for future newsletters, so please don't hesitate to reach out.

Happy Investing!
Richard L. Peterson, M.D. and The MarketPsych Team