Stock market drift and psychology

Over at Daily Speculations, Victor Niederhoffer re-emphasises a central tenet of his investment philosophy that is well worth bearing in mind, particularly for investors in the equity markets:

“One must repeat that the unconditional drift of the market is 10% a year. Whenever you are short, you have a drift going against you. When you wish to go short, chances are that the drift of the market will be above 10% a year. That’s because you and others think there’s a bear market retrospectively, and require a higher rate of return to be invested. In addition there are frictional costs to being short. Put them all together, and I’ve never seen a short seller who’s made money, nor has the Palindrome (Soros) . It does give psychic value however in that it lets you vent your hatred of the system and yourself. It also gives stature because you are always on the negative which seems so much more poignant than the positive.”

Following up on this, trading doctor Janice Dorn provides an interesting insight:

“Part of the profundity of Chair’s remark is that the bears make poignant arguments which are almost tailor-made to touch something very deep inside of those who are always watching and waiting for some disaster or catastrophe. The bearish arguments tend to be more scholarly, detailed, laced with Latin words and appeal to the limbic core of the brain (which holds memories of fear and terror and sees them even in their absence), as well as the higher neocortical areas which are, in some way, hard-wired to process, consolidate and retain bad news more firmly and longer lasting than good news. Bad news is stored as pain and that pain can be evoked in almost any situation. Good news tends to be more fleeting and there is more difficulty reaching into the brain stores to retrieve the memories of euphoria. Perhaps the neurochemistry of euphoria (be it dopamine, serotonin, norepi, or any of the thousands of neurochemicals) is configured in a way as to be more transient, spontaneous and non-entrained. Depression, disaster, danger lurking around every corner is much more “reachable” in terms of our psyche. Once again, this is likely a function of the way that the cortical neuro-pathways are laid down and communicate electrochemically with each other in the vast cortical landscape.

In any case, the rah-rah cheerleaders are often seen as buffoons, whereas the permabears are the scholars and masters of Latin.”

I believe drift becomes a more important feature the longer the holding period of the investment, but the general ideas above are relevant to all traders, even for fx traders despite the absence of a long-term drift in most currency pairs. The material certainly provides food for thought. From personal experience, for example, I would say there certainly seems to be a lack of symmetry in human psychology when one contemplates bullishness and bearishness. I find that bad news is so much easier to sell, and not just for journalists, bloggers etc, but even in terms of the conversations we are having with ourselves as investors.

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