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Is the Market Ever Wrong?

Posted by Larry Doyle on June 24, 2009 8:00 AM |

The market is often wrong, right?

Human psychology, being what it is, drives individuals to believe they are always right, or at least most often right. What highlights this instinct? The fear of  an actual loss. What do I mean?

Most individuals do not want to readily admit that they may be wrong, especially when it comes to money and finance. This human frailty leads individuals to make financial decisions which are often not in their best interest. Let’s navigate and address this psychological aspect of trading and investments.

During my trading career on Wall Street, I often encountered traders who were paralyzed by the market price action. This paralysis occurred during periods of significant volatility. Often, I would hear these individuals utter 4 simple words which should never enter the lexicon of finance: “the market is wrong.”

In response to that statement, I would ask them “if the market is wrong, then why aren’t you either buying or selling it to capture the difference in value between the market’s ‘wrong’ level and the ‘right’ level?” Those conversations were often short lived. Most traders would voice their opinion about the market — while not acting on it — in order to defend their ‘marks,’ that is, the price at which they were carrying trading positions/investments.

Nobody likes booking a loss or actually recognizing a loss. However, the reality of life is that many times we are faced with that unpleasant phenomena. The last two years provides a wealth of evidence on this front. I am reminded of it again this morning in a Bloomberg story, Home-Price Recovery in U.S. May Be Undermined by Appraisals:

There may be another culprit scuttling a U.S. housing recovery: low home appraisals.

Flawed appraisals are derailing real estate sales and depressing values across the U.S., the National Association of Realtors said yesterday as it reported that existing home prices declined 17 percent in May from a year earlier.

“It’s pointing to thousands of delayed or canceled transactions,” Lawrence Yun, chief economist of the Chicago- based Realtors group, said in an interview. “We’ve had a massive inundation from members saying this is a big problem.”

In so many words, Mr. Yun is ‘talking his position’ and indicating that the market is ‘wrong.’ A market may be deemed to be ‘oversold,’ ‘overbought,’ or otherwise ‘mispriced.’ However, those assessments are opinions and not fact. Very simply, a market is never wrong.

When home values come in below the sales price, that’s not the appraiser’s fault, it’s a reflection of the market, the Appraisal Institute, a Chicago-based professional group that represents more than 25,000 appraisers, said in a statement yesterday.

“We take offense with the notion that an appraisal is only good if it happens to come in at the sales price,” the group said. “That mentality helped cause the mortgage meltdown to begin with.”

Let’s look at this phenomena from the opposite standpoint, that being a rising market. Is the market right? Are you, the investor, as smart as you may think? Never confuse brains with a bull market.

As difficult as it may be, individuals should eliminate human emotion and psychology from financial decisions. The market is neither ‘wrong’ nor ‘right.’ The ‘market is the market.’

LD






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