Thursday, July 23, 2015

A New "Era"

Decades are a peculiar thing. Every ten years, historians bolstered by media package the time that has passed and choose a unique name for the so-called era. The years of 1920-1929 were deemed the "Twenties," as a way to segregate those years of prosperity with the horrible "Thirties" of the Great Depression. Consequently, the "Fifties," the "Sixties," and the "Seventies are all characterized by their postwar days of the Cold War and technological change. The numbers we assign years continue to define history, and nobody decides to ask the question why or assert the point that the onset of a new year, a new ten years, or even a new century is nothing but a continuance of time. Decades and centuries don't exist as much as our fabrications of eras divvy up time like a master sous chef parsing a long carrot into equal sections. Anyway it's sliced, it's still carrot and it's still time. But why all the boredom with time and carrots? Perhaps my questions boil down to a simple experiment that would tell a lot about the human mind and timekeeping:

Which years brought about more change?
  1. 1654-1655
  2. 1659-1660
The question and answers are vague for a reason because I, as the observer, am not interested in the history behind those years but rather in the change of the ten's place. My hypothesis would be that most people would choose Option 2 on the basis that it signals the beginning of a new decade. And my hypothesis extends that even the most educated men and women would fall for this trap called anchoring. In reality, there is no difference between the change from 1657 to 1658, the change from 1659 to 1660, and even the change from 1999-2000 except that which is fabricated by the human species (e.g. Y2K). To sum it up, the effects of anchoring, a mental state of fixation on a certain characteristc, data point, or any perceived stimuli, causes us to attribute more importance to change that seems larger.

In the past two weeks, WTI crude oil prices have dropped into the $40's with the Iran deal threatening more production and U.S. supply increasing. Many investors do not need to be told the significance of the new lows as they introduce a whole array of possibilities such as $48, $45, and even $40. Before these two weeks, these prices were rarely thought plausible as the price hovered in the $50's, so outlook remained bearish. But speculation is a funny thing. It is about sentiment, opinion, and most of all the psychology of the herd behavior that creates it. Just like the turn of a decade, crude oil prices have dipped into a new "era," and that "era" is ushering in a new line of thinking. Once again, that thinking is faulty and fabricated. Think about this question and what investors might say to it:

Which price change is more significant?
  1. $53.73 to $52.73
  2. $50.73 to $49.73
Once again, my hypothesis remains that Option 2 would be the hot commodity in this selection. Accompanied by the choice is speculation by traders, by economists, and by news media that amuse themselves and the public with the conclusion that a new approach to the crude approach is needed. Short positions are exited for long positions as the consequences of prices in the $40's are revealed. Even pre-programmed trades will respond to the change in the ten's place as automated traders fixate upon a $50.00 floor. The mathematical reality is the price changes in Option 1 and Option 2 are identical and a needless anchoring has taken place. So what predictions can be made as oil slides to $48 dollars and possibly less as the day goes on? Unless prices breakthrough a hypothetical price floor of $50.00 and show a strong down trend, I predict a small bullish uptrend lasting for about 7 days given that negative speculative news is held to a minimum. Traders will begin to establish more long positions in the "$40" state of mind as short positions will be cashed out. Herd behavior will support this trend back to hovering prices centering around $51. Inevitably, a volatile period will take over until supply data starts to show significant declines in which the "$50's era" will be endangered for a movement into the "$60's era" where a new segment of speculation, exiting and entering, and anchoring will consume price movement and trend making.

It is inevitable and it should be a reminder that "as traders, we trade other people, not stocks" (George Fontanills).

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