A Useful Timing Mechanism For The S&Ps
I wanted to start
today’s piece with a quote from an excellent commentary I read over
the weekend from Credit Suisse First Boston
(CSFB), not only was it interesting, I think it also dovetails in nicely with
the market presently:
The Downside of
Hard Wiring
In 1979, Daniel
Kahneman and Amos Tversky outlined prospect theory, which identifies economic
behaviors that are inconsistent with rational decision-making. One of the most
significant insights from the theory is that people exhibit significant aversion
to losses when making choices between risky outcomes, no matter how small the
stakes. In fact, Kahneman and Tversky found that a loss has about two and a half
times the impact of a gain of the same size. In other words, people feel a lot
worse about losses of a given size than they feel good about a gain of a similar
magnitude.
Bulls, Bears and
Odds
In his wonderful
book, Fooled by Randomness, Nassim Taleb relates an anecdote that beautifully
drives home the expected value message.3 In a meeting with his fellow traders, a
colleague asked Taleb about his view of the market. He responded that he thought
there was a high probability that the market would go up slightly over the next
week. Pressed further, he assigned a 70% probability to the up move. Someone in
the meeting then noted that Taleb was short a large quantity of S&P 500
futures—