Big Round Numbers
Big Round Numbers
August 13, 2010
I’m thinking of starting my own stock fund. The fund would buy and sell the DOW index according to two simple rules.
- When the DOW is exactly 300 points below a big round number such as 10,000, 11,000, 12,000, etc., the fund would buy the stocks in the DOW, weighted the same as the index.
- When the DOW rises above its big round number by 300 points, the fund would sell everything.
To be smart, the fund would stay on the sidelines if the market was crashing for some obvious reason. But in normal choppy markets, it would be coming in and out according to the rules. The strategy needs some tuning, but you get the idea.
This trading strategy is based on the presumption that people make irrational decisions based on big round numbers. When the DOW is near a big round number, people start imagining, and hoping, it will cross that threshold. So they buy stocks, making it a self-fulfilling forecast. Once above the big round number, the DOW tends to drop below it at least once, usually because of economic news.
I know, I know. If this strategy worked, someone would already be using it, and you would know about it. What fascinates me is that it feels to me as if it would work while at the same time every bit of my knowledge, experience, and common sense tells me it couldn’t. And even if it has worked in the past, that tells us nothing about the future.
For most of you, this idea was nonsense right out of the blocks, so your instinct (or feelings, or intuition) matches your common sense. But I’ll bet there are some areas of your life in which your intuition and your judgment are at odds, and you are totally aware of it even as it happens. It’s like having two brains, and one of them is an idiot.
Your rational brain has language skills. It literally thinks in words. As you work through a problem, you put it into words in your head as if you are planning to explain it to someone. The idiot part of your brain simply feels. Your rational brain tries to stay in charge, but it’s a battle.
I have a theory that the rational side of your brain is only as strong as your language skills. You assume that a person who is logical can, as a result of that logical facility, write a clear and persuasive sentence. But I think causation works the other way. I think language creates logic. The stronger your language skills are, the better your logic becomes. You can never be more rational than your vocabulary allows.
It took me nearly fifty words to summarize my stock fund idea. When it takes that many words to describe something, it’s fertile ground for irrationality. If tomorrow someone comes up with a nifty and derisive phrase for my stock fund strategy, as powerful as phrases such as “pyramid scheme,” or “catching a falling knife,” it would be easier to control the irrational part of my brain that thinks the stock fund would work.
Everyone agrees with the caution “Don’t run with scissors.” Language describes the idea so clearly that it somehow seems more logical than it is. Do you know anyone who was injured by running with scissors? You probably don’t, although literally every child in the civilized world has done it. By way of contrast, you know plenty of people injured by non-scissor running.
Be wary of any idea that requires a long explanation. That’s a red flag. And be twice as wary of anything that can be explained in four words or less. That’s a red flag too.
Yes, I did just tell you to be wary of my blog posts. it’s sound advice.