Asset management, Behavioral finance, Commodity price, Complexity, Economics, Expertise, Hedging, Market psychology, Psychology, Stock market, Trading, Trend following

The illusion of expertise in financial markets

Participants in financial markets have to deal with uncertainty on a daily basis. Their need to research and understand markets has given rise to a massive industry delivering security prices, reports and expert analyses to traders and investors seeking to make sense of the markets and predict how they might unfold in the future.

The need to understand stuff is innate to our psychology: when something happens, we almost reflexively want to know why it happened. But the compulsion to pair an effect with its cause sometimes gets us jumping to conclusions. If such conclusions turn out to be mistaken or irrelevant, they could prove useless – or something worse. Consider two recent titles from the ZeroHedge blog, published 89 minutes apart:

ZEROHEDGE, 5 Jan 2017:

10:07 AM: “WTI, RBOB Tumble After Massive Product Inventory Builds” (WTI is a grade of crude oil; WTI=West Texas Intermediate; RBOB is a gasoline blend)

12:36 PM: “Crude Jumps On Report Saudis Fully Implemented OPEC Output Cut

On 5th January 2017, crude oil first declined a bit and later rallied. Commodity prices rally and decline (or vice versa) most days. If you follow MSNBC, Bloomberg TV, or any similar financial channel, you invariably get a daily stream of near-constant explanations for why such things happen. Here are another two examples:

REUTERS, Tuesday, 1 Mar 2016

10:00 AM: “Wall St gains as weak data spurs stimulus hopes

11:45 AM: “Wall Street surges as data points to economic recovery” (Reuters said data was weak less than two hours earlier)

REUTERS, Thursday, 10 Mar 2016

8:21 AM: “European stocks rally after ECB unveils more stimulus

3:59 PM: “European stock turn lower as ECB says more rate cuts unlikely, banks up.”

It’s understandable that financial press couldn’t sell their wares if their titles read, “Oil prices went up and we don’t know why,” or “Stocks fall for some reason”… However, this constant interpretation of why the markets ticked up or down is only useful as a way of keeping the appearance of expertise. If constant information monitoring and ‘explaining’ of market fluctuations actually produced any value, we should expect the best informed professionals to outperform their peers. But that is not so.

In financial speculation, more information doesn’t necessarily improve decisions. An experiment conducted by psychologist Paul Andreassen at the Massachussetts Institute of Technology looked at the way access to information influenced investment performance.

Andreassen divided his study’s participants into two groups whose members each selected a portfolio of stock investments. In each group, students were free to buy and sell stocks as they saw fit, but while one group had access to constant flow of stock markets news, the other could only monitor their portfolios through changes in stock prices. Students who got no financial news at all earned double the returns of those who frequently checked the news.

We might, at this point, feel compelled to grasp for an explanation for this phenomenon too, but this should lead us to study, not markets and economics, but human psychology which is, and will forever remain, the driving power behind all market changes. So if you wish to excel as a trader, make psychology the focus of your research. Better yet, study market trends which are the cumulative effect of human psychology in financial and commodity markets.

Alex Krainer is an author and hedge fund manager based in Monaco. Recently he has published the book “Mastering Uncertainty in Commodities Trading“.


3 thoughts on “The illusion of expertise in financial markets

  1. Nice article Alex! I was nodding along the whole time. But what really got me was that study you referenced where students without news outperformed. That pretty much confirms that headline information has very little value to speculative decision-making.


  2. Vin says:

    I remember when I started working in Finance, trying to understand 1) these occasional conflicting rationales and 2) how journalists were able to pinpoint the driver of a move so precisely. Then I arrived at the conclusion presented here that a lot of it is BS, pretense and about perception and time was better spent doing my own analysis! Thanks for the post!


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