Monday, January 30, 2017

SPX and RUT: Why a Fun-damental Bias Isn't Always "Fun"

I was skimming through some of my old articles this weekend, and I want to share something briefly that might be worth a reread, particularly for bears.  The article I'm quoting from was about how our underlying fundamental biases can cost us money.  The point I made early in the article was that we are all more forgiving of our errors when they're in the same direction as our fundamental bias.  So bulls can forgive themselves more easily for making bullish errors, while bears can forgive themselves more easily for being "short and wrong" than they can for being "long and wrong."  As a consequence of this psychology, even when bears know they probably should be long, they will more quickly accept a short entry than they will accept a long entry.  This can be pretty devastating in a bull market.

The article I referenced above then attempts to explain the psychology behind those errors:

I'm not sure if I can explain this in a way that makes sense, but I'll try: our beliefs represent what we stand for in this world.  And what we stand for in turn represents who we are, in a meaningful sense.  At least, it has meaning to us on a personal level.  Our beliefs generally represent the core foundations from which we build our enduring life principles -- so beliefs translate into action.  As a result, we all associate "who we are" with our beliefs to a greater or lesser extent, depending on the depth and strength of the belief.  This is why religion and politics are such heated forums -- people feel criticized on a deeply personal level when those beliefs are challenged.  They feel you are attacking not simply their ideology, but actually attacking them as individuals. 

Anyway, I think this human tendency is one of the challenges that makes it so incredibly hard to get away from our fundamental bias.  It's much easier to forgive ourselves when we err on the side of our fundamental bias, because that error is in line with our self-image -- it's "who we are" to some extent. And we can always forgive ourselves for "just being ourselves" (we do it all day long!).  Conversely, that same psychology causes us to criticize ourselves much more harshly when we err against our fundamental bias.  Which in turn causes us to make more errors toward the side of our bias.

It's worth examining.  We all have a fundamental bias -- and I suspect it costs every one of us money at times.

Moving on to the charts, SPX is still trading within its red channel of the past several months:

RUT has, so far, stalled shy of its recent swing high:

I'm not focusing on the near-term in this update because the near-term has, lately, been filled with very unusual patterns, so I don't trust the "obvious" patterns right now.  I'll update the near-term counts when appropriate -- in the meantime, bulls will want to keep an eye on the dashed black trend line on RUT, and the dashed red trend line discussed on the SPX chart.  Trade safe. 

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