How to become a market wiz?

Reflexivity, simplicity, and unity

Magic is a phenomenon we do not understand. Simply, our left hemisphere classifies it as impossible.

We live in an epoch ruled by logic. Our thinking about markets obeys the left part of our brain, and two contradictory fallacies emerge. No one can beat the market; superior analysis is enough to deliver Alpha.

The first equals generating Alpha to magic, while the latter oversimplifies the investing process. Read the first sentence in the introduction again.

To beat the market is possible, but research quality is far from enough.

Strongly disagree?

If it cannot be explained with a spreadsheet, it does not exist. Conventional science reigns supreme. It applies normative logic to fuzzy objects.

What is the most illogical entity in existence?

A human.

We are rational only to justify our irrationality. Despite that, we believe we are sane, or at least there is no way not to be. The result is sterile, left-hemisphere thinking, which, applied to markets, is a myopic and costly fallacy.

The made and the born

Left-hemisphere thinking is perfect for dissecting machines. All variables are known, and their interaction is predictable and measurable. For example, if I expand the combustion chamber volume of ICE (all else being equal), engine output will increase.

Now, apply that mental framework to markets. For instance, FED announces rate cuts by 25 bps. The market can interpret the news in a few ways:

• Good news. The printer goes BRRR. The markets are ecstatic

• Bad news. This is the last FED cut. The printer is going off because this cut is lower than the previous one. A sad mood takes over.

• Neutral news. The printer is neither BRRR nor off. Mr. Market is indifferent.

As presented, those are discrete events, i.e., considered in isolation. Typically, Mr. Market is way more creative. For example, on day one, FED cuts may be regarded as unfavorable; however, the news is good on day two. And this is one scenario, considering only two events.

But investing is supposed to be easy. The market consists of rational agents that possess all the information and act accordingly in the most logical way. This is true if the market is a machine. Yet, it is something qualitatively different.

If I apply Kevin Kelly's framework, the market is a blend between “the made and the born. " It is the ultimate device for distributing information where all elements are cause and effect simultaneously. Markets are reflexive by nature.

Reflexivity, simplicity, and unity

Like all social systems, the markets are driven by three variables: reality, circumstances behind the reality, and perception of the reality.

Market news presents the narrative, the perception of reality. The reality is the price and circumstances are the fundamentals. These three variables form a reflexive feedback loop.

Therefore, on the day of the Fed announcement, we assume the news is the only key factor impacting the reality (price) while ignoring the circumstances (fundamentals). We interpret news binary: lower rates, higher equities, and vice versa, ignoring the interdependence of all three.

Reflexivity is continuously in play, and there is no point in stable equilibrium. Markets swing between stable-ish equilibrium and unstable equilibrium. To emphasize, equilibrium does not imply market efficiency or balance. It describes the interplay between buyers' and sellers' forces.

It sounds simple, isn’t it?

Figure out demand and supply and position accordingly.  True, the game is simple, yet not easy.

We oversimplify complex things and overcomplicate simple things. In investing, the former means ignoring execution: sizing, timing, and management. The latter implies overconcentrating on research and valuation.

The mainstream belief is that the more elaborate our research process, the better the outcomes. On the other hand, execution is treated as more suitable for day traders—another costly mistake. Fancy DCF formulas and nerdy spreadsheets do not compensate for the lack of risk management.

Then what to do?

Employ our full computational power. The goal is to determine the relationship between reality, circumstances, and narrative. The left and right hemispheres must work in unison.

As market participants, we perform qualitatively and quantitatively different tasks simultaneously:

• See the tree and the forest at once.

• Connect the past with the present and the present with the future.

• Act tactically but think strategically.

The left hemisphere lures us with ordered thinking, while the right scares us with its chaotic flow. Relying on the left results in an incomplete thesis. Using only the right part of the brain is dangerous, too. We miss the focus and attention to detail. The key is unity between logical reasoning and flow perception.

Final Thoughts

It all started with the definition of magic. One of the most influential investing books is “Market Wizards” by Jack D. Schwager. The name tells it all.

For left-hemisphere individuals, market wizards perform magic. In reality, they sync the left and right parts of the brain. To become your version of a market wiz, view the game in a multidimensional way.

Think about the part and the whole, the future and the past, the point and the flow.