Editor's note: In this Weekend Edition, we're taking a break from our usual fare to explain why you shouldn't always trust what you see. In this essay, adapted from the September 26, 2022 Ten Stock Trader Weekly Market Outlook, editor Greg Diamond relates sports statistics to investing to show you how the "human element" in both can often lead to unexpected outcomes... for better or worse.
I have a confession to make, and it might change the way you think of me...
I'm a New York Jets fan.
If you're familiar with football, that might have made you chuckle. If you don't like football, you probably don't care. But I'll explain how it relates to what's happening in the market – whether or not you like the game.
Now, I'm not a sports "fanatic" in the true sense of the word. I like sports, have played sports, and think sports can teach valuable life lessons. But I won't paint my face or watch every game.
The truth is, the older I get, the less sports I watch.
With a demanding job and two little kids, there's only so much time to go around.
And watching my football team lose consistently year after year isn't exactly how I want to spend a few hours each Sunday.
But what I'm going to explain in this essay combines sports statistics and market statistics. And I'll show you why you shouldn't always trust what you see in either...
On September 18, I was out with my family and knew the Jets were playing against the Cleveland Browns. I happened to check the score and saw the "win probability" for each team.
Simply put, this is the statistical probability of a team winning. It's based on certain criteria that a computer or algorithm applies throughout a game...
As you can see, the Browns were favored to win throughout most of the game. In fact, the win probability hit 100% with just a few minutes left in the game.
That's when I checked the score. I figured it would be another loss for the Jets, and I would just get on with my day.
But beyond probabilities and statistics, there's a "human element" that computers, analytics, and algorithms just can't calculate...
Never giving up.
The game isn't over until it's over.
The Jets scored a barrage of points within the last few minutes of the game and pulled off a miraculous win.
That's great... But what does it have to do with the markets?
It comes down to the same principle – that beyond the calculations, the human element can take you by surprise...
On September 9, investment research and analytics firm SentimenTrader highlighted the chart below. It noted extreme readings in hedging positions (when institutions buy put options) for the past 20-plus years.
Looking at this chart, you can see that the panic-hedging in early September was three times more extreme than the one in 2008 (the height of the financial crisis)...
Now, the contrarian trader or investor would think this is an easy trade... by taking the opposite side of all this put buying (in this case, buying stocks or call options). When the crowd is bearish, it pays to be bullish. It's what we expect with a rally.
But that's not what happened...
Below is a chart of the S&P 500 Index from January 2022 through its October low. As you can see, the index is in a bear market. The black dashed line marks lower highs of that downtrend. I highlighted this simple analysis throughout 2022 in the Ten Stock Trader service.
The record number of hedges from traders (marked with the red arrow) was followed by a small rally... before stocks kept declining. Take a look...
So what's the takeaway?
Sometimes the crowd is right.
As the saying goes – especially in sports, but also in the market – some records are meant to be broken. And in almost every new bull or bear market, it happens all the time.
2022 was no different.
The bear market isn't over until it's over (just like a football game). And despite what appears to be a record number of short positions and sour sentiment, the trend could remain in place longer than some think.
The statistics can be misleading. As a contrarian investor, you're usually going to make good trades when the statistics and probabilities are in your favor. But that's not always the case.
As with everything in the market and investing, nothing is guaranteed.
Looking ahead, I'm expecting more volatility and new lows in the majority of technology stocks.
Good trading,
Greg Diamond, CMT
Editor's note: One year ago, Greg predicted a market crash. And almost like clockwork, we saw the worst sell-off in half a century unfold. Now, Greg is sharing his prediction for 2023. He says it's the greatest inflection point he has seen in two decades... And it could double your money 10 different times if you know what to look for.
It all boils down to one strategy that dates back to 1876... and it's pointing to a historic market move on the horizon. Click here to learn more.
