Another One Question Interview, this time from Brett Steenbarger. Brett always has insightful commentary on the markets and his response this time is no exception. I did a full interview with Brett a few weeks ago and I took a look at his book recently as well. I’m almost finished with his book (Psychology of Trading) and I’ll be posting some more comments on it soon. (I think it’s a gem.)
Here’s the question for the first round of One Question Interviews:
What trading lesson(s) have you learned from the downtrend that started in May?
The move since early May has driven home for me that these are, indeed, global markets. Behavioral finance researchers remind us that we tend to overweight information that is most salient (i.e., that is right in front of us). That salient information tends to be the market we trade and the time frame in which we trade it. In reality, however, the longer-term drivers of market movements are global movements in currency, interest rate, and commodity markets, as well as monetary/economic conditions.
In a bull market, there is a natural correction of upmoves that creates a pattern of higher highs and higher lows. When, however, we get fundamental shifts in the global markets, those natural corrections can result in something longer and deeper. That is what we’ve seen since May, with the rise in global rates, the unwinding of the carry trades that borrowed money from low-yielding economies and parked them in higher-yielding currencies, the risk aversion and resulting drop in emerging market shares amidst evidence of a slowing economy and geopolitical uncertainty, and continued oil price strength and threats of possible shocks.
The lesson since May is that the big picture does really matter. It’s important to track price and volume, but the patterns that work in one market environment can fail miserably when that environment changes.