A few days ago at a conference I heard the following sentence: “drink food and eat water”. At first, I thought the speaker wasn’t feeling well, but in reality this phrase has a profound meaning: we must chew our food well until it liquifies and water must be kept in our mouths for a long time before ingesting it.
The phrase is counter-intuitive and strives to convey that the right way to behave is the opposite of what common beliefs teach us from a small age.
Why are financial markets counter-intuitive? Simple. Have you ever met a person who invests in a stock in order to lose money? I haven’t, but I’ve met many people who have lost money in the stock market. Even people who think they’re acting correctly, could be missing things that cause them to make mistakes. If the markets were intuitive, everyone would gain from investing in them, but because they are counter-intuitive, people fall into their traps and behave in the wrong way.
It happened in 2009 when the markets were at record breaking lows in terms of indices, but this often happens in the case of individual stocks or sub-periods as well.
This is one of the main reasons I don’t believe in phrases such as “sell in May and go away”, a motto that has often worked, but what if by chance you apply it at the wrong time? “Murphy’s law” is very punctual at striking in moments like this.
Murphy simply realized that people need plenty of confirmation before acting and tend to make a move when it becomes statistically unlikely that a phenomenon will continue to manifest.
I’ll explain better. If you notice that for the last 10 years, selling in May and buying back in October would have been profitable and you decide to sell in May, you’re actually exposing yourself to the possibility of losing because there is very little basis on this market rule. If you decide to sell in May and in October you’re forced to buy higher, blame your statistical lack of preparation for understanding market phenomena, not Murphy.
In saying this I’m also exposing myself to the opposite possibility, which is that selling in May and buying back in October would have been the best operation of the century, but too bad, I’ll willingly risk my reputation to support the growth of statistical culture and in the name of never hearing speeches like “sell on the second Monday and buy back on the third Wednesday” ever again.
Finance is one of the only activities where you can rewind the tape as many times as you want, and simulate what would have happened if…. (not the case with sports for example).
This practice always leads to finding alternative solutions that could have gone well, but of course hindsight is 20/20 and retrospective analyses on mean and variance models are practically useless because we must make decisions ex-ante under conditions of uncertainty.