How we deal with uncertainty influences our outcomes, in life and in markets. In the present environment, I see investors making two mistakes that are likely to hamper future returns:
First, there is a natural human tendency to reduce the anxiety of the unknown by latching onto seeming answers. Psychologist Robert Cialdini cites research that shows how the critical thinking areas of our brains tend to shut down when we are exposed to expert advice. That makes us vulnerable to any perceived expert expressing a high conviction view, resulting in a herd mentality among professional money managers as well as individual investors. As uncomfortable as uncertainty can be, the pain of losses from following the herd can be much greater. The social media site Stock Twits follows the proportion of bullish and bearish posts for stocks and exchange-traded funds (ETFs). Most recently, at the mid-May stock market lows, we saw 75% of posts bearish and 24% bullish. Following the herd would have proved quite costly.
Second, amidst poor financial performance, it is easy to fall prey to negativity. As Cialdini observes, this can take the form of reflexively finding counterarguments to even the best ideas. Just when we most need to be open-minded, we can shut down with a mindset that “nothing is working”. Language plays a significant role in shaping our realities. When we describe markets as “choppy” and “noisy”, we define them as completely devoid of opportunity and shut down risk-taking altogether. This leaves us ill-prepared to act on opportunity when it does appear. Several trading professionals I work with have used the current environment to successfully diversify their strategies, mixing selective growth-seeking with a search for relative value and yield. Like any good entrepreneur, they have used the challenges of a difficult marketplace as a prod for innovation.
So how can we avoid falling prey to so-called experts and crippling negativity during difficult market periods? One technique I particularly like is constructing a variety of what-if scenarios that highlight risks and opportunities under different conditions. Keeping open to multiple scenarios and staying opportunity-focused among each is a great way to stay active and creative in the face of uncertainty. A recent scenario I’ve been playing with is the possibility of “helicopter money” coming from global central banks, given the growing perception of diminishing returns from quantitative easing and negative interest rates. Directly issuing money for spending in the real economy is an idea finding some traction in Europe and actively contemplated by the Fed chair in response to extreme situations. Yet another scenario would be one in which uncertainties about terrorism and the U.S. elections find their way into persistent, elevated market volatility.
Success comes, not from predicting the future, but from being prepared for a variety of futures.
This article was written by Brett Steenbarger from Forbes and was legally licensed through the NewsCred publisher network.
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