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  • CK Narayan

    Contributor, ET NOW
    Dr Narayan is a Dalal Street veteran and one of finest exponents of Technical Analysis in Indian financial markets. He has nearly four decades of experience and insights on Indian markets and is popular for his talk show, Talking Technicals, on ET Now. He is also Chief Mentor at ChartAdvise.

When you trade a forecast, you get caught in a cobweb

The market is reality, our forecasts about it are expectations and only in our minds!

ET CONTRIBUTORS|
Jun 20, 2019, 01.28 PM IST
0Comments
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We are all so obsessed with the future because that’s where all our riches, we tell ourselves, lie, are to be found or are to be created.
Markets run on earnings, and that is a commonly-used dictum. The entire market is, therefore, into forecasting what those earnings shall be. A number of methods are used and practitioners of each one of them claim their approach is the best. Or it is the best that they can do.

After all, there has to be the ‘capability’ to make forecasts. This so-called capability is what creates jobs and businesses. Both jobs and businesses seek to satisfy the demand coming from the marketplace. And the demand is: what’s going to happen in the future?

We are all so obsessed with the future because that’s where all our riches, we tell ourselves, lie, are to be found or are to be created.

So, the race is to make forecast. The next quarter, the next year, the next 5 years or even the next hour or next few minutes for those looking at the shorter timeframe.

It’s all about what is going to happen next. Even those who talk about the next five years are not immune to what is going to happen next, they just pretend that it doesn’t matter.

So newer and newer methods are devised, older methods are rejigged, technology is brought in to create tweaks and speed up information processing. More and more data is looked at and linkages are established between data sets that nobody ever thought of before. Because no one is quite sure what is connected to what, no one questions these approaches.

They just look at the stuff that they think they are able to handle and perhaps do. So the larger the player, the more data you can collect and bigger the data crunching you can do in the hope that your output will be better than that of next guy.

You narrow it down to stuff like value, valuation, earnings trajectory, visibility and reliability of outputs, etc. For the guys projecting price levels, it is price action and trends, more momentum indicators, more ways to measure and handle volatility.

Finally it’s all about controlling risk and keeping it within a certain band and then programming the machines to handle all of it.

Never mind those occasional flash crashes; they are just small glitches in the overall big structure, we tell

ourselves, overlooking the fact that every time something like that happens, it is like reaching 98 on the Snakes and Ladders board and getting bitten by the snake to send you down to 11!

But hey, you have your data crunching machines and the associated nonsense to help you make it back to 98 again, right?

Data in India is said to be limited and, hence, we do not have the kind of ‘extensive research’ that the US analysts are able to put out. So, you would think the vastly greater amount of data that is available in the US ought to produce more reliable ‘forecasts’, right? That would be logical to think.

But, pause here to take a look at this chart.

Bond markets are giants and biggest banks and players are part of them. So there is no dearth of ‘talent’, supposedly, in this space. Now, take a look at the result of that talent pool in

forecasting something as basic to the market as bond yields. Could something have been more off the mark? I am sure the guy at the top end of that prediction for June is now out of his job!

That, even when the entire data has been assessed by some of the finest brains using the most sophisticated computers and running the best algorithms for the longest time, cross-checking hundreds of combinations and possible outcomes.

After doing all that, we presume, analysts came out with their forecasts.

Doesn’t this show no one really knows anything; most of all, those are supposed to know?

Where does that leave us? Should we do this stuff at all? Is it all just some ‘roll of the dice’? Are we all existing in this incredible make-believe world of useless forecasting?

Perhaps, we are. The question is can we live without it?

The future is one big hope. All the things that are not in the present or that we wish were there are all hoped for in the future. I want to buy stocks where I am certain about earnings and growth for next four to eight quarters. I want to know that today. Since that is not possible, the next best thing is

to forecast it. This helps me create an image of certainty, create a sense of comfort on what I am about to do and have a sense of security that I am not acting randomly. Forecasting is essential, because we want the ideal. Our actions are then directed to achieve this ideal. We want to mimic all those who are engaged in the pursuit of the ideal.

Rene Girard, the Stanford professor who champions contrarian thinking, calls it ‘Mimetic Behaviour’. In the case of the bond yield forecast shown earlier, it is probably this ‘Mimetic Behaviour,’ which is at work.

Analysts within the fraternity probably know each other and certainly follow each other’s work. The tendency towards ‘Mimetic Behaviour’ influences the way we think and once we find that the forecasts are all tending towards the positive, it is difficult to go against the grain. I recall some people giving a very contrarian, deeply bearish forecasts for Reliance Communication and Indiabulls group a while ago and they were castigated for that blasphemy!

No one believed those seemingly dire forecasts back then, but subsequent price actions proved them correct. It was ‘Mimetic Behaviour’ back then and it is once again, ‘Mimetic Behaviour’ now which got us this yield forecast that bombed across the board!

I myself am in the business of forecasting. In fact, I have done this for decades. It has worked out okay, but I am certain there are countless forecasts that bombed which my mind would prefer not to remember. Like me, there are a thousand others who are also in the business of forecasting.

We are in search for an ideal too; of being able to know what is going to unfold in the future and the way it is going to unfold. We are doing it for ourselves and for the sake of our clients who ask for such services (to satisfy their own search of the ideal).

How do we ensure that we do not become victims of our own forecasts or indeed fall victim to other’s forecasts (Mimetic Behaviour)? For one thing, I would think the more we desire an ideal outcome, the more is the tendency to believe and follow a forecast. So have a check on how badly you want a certain outcome. That can be tempered through other means and the problem can be reduced to a certain extent.

In the market, one of the maxims to follow is something Robert Miner, a veteran market technical analyst, once said: ‘Never trade a forecast, always trade the market.’

This maxim, which I have made my own over the years, has prevented me from being caught in the cobweb of forecasts that the market throws at you every now and then.

The market is reality, our forecasts about it are expectations and, therefore, it is only in our minds! Follow reality, that is what Miner suggested!

Value investing is in fashion these days. This is one of the areas where ‘Mimetic Behaviour’ appears to be dominant. Warren Buffet is a hero. There are many blind followers, some of whom have also become a bit iconic, and thus heroes for those lower down.

This is a very two-dimensional world. There is the hero and the goal (the investing model) on one side and there are obstacles (the market) on the other side. This is now made into a battle of the hero (i.e. the Model) vs the obstacle (i.e. the market). But the reality from this fairy tale is quite different; it is a two-dimensional model. People’s emotions, random events, constant barrage of information and technology enablements are all new villains that create many more dimensions, which take us out of the ideal two-dimension setup where good (the model) wins over the bad (the market).

To win this, normal people fall back on what the icons are saying or forecasting! And make it their own.

Rakesh is still holding stock X, they rationalise. Damani has bought truckloads of stock Y, they justify; even as both X and Y keep tanking way beyond what the normal investor can afford.

They overlook a simple fact that Rakesh or Damani have the means to hold those stocks into infinity, because they have the money and they probably form a minor part of their portfolios. But for the normal investor, it is probably 10 per cent or more of his portfolio (after all, it was bought because of Rakesh and Damani owned it!).

So, if we believe the Girardian model of human behaviour, then a dose of Robert Miner practicality is the only solution in not getting trapped into something that we innately have to make (i.e. forecasts), but at the same time we have to protect ourselves against.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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