HUMMONEY - Monkey See (Perspective)

By Greg Lewin (3/11/11)

A recent article published in the Financial Times titled “Decoding the Psychology of Trading” analyzed the strategies employed by systematic or computer based investment firms. The 2 core premises on which they began to develop formulas by which their systems operated were:

- Investors are irrational.

- The financial industry will quickly jump on any new trend.

Interestingly, a recent article in Businessweek discusses the recent transition of leadership to a currency trader at one of the largest and most successful hedge funds in the world. To paraphrase his operating strategy:  value in currency trading is not absolute, it is relative, and that is why we are very attentive to markets and we respond to change in market behavior aggressively.      

So if the presumption of those who know is that investors are irrational and the strategy of the best and brightest is to transition from absolute value (fundamental behavior) to relative value (trading behavior based on market behavior), then investment outcomes can be expected to be increasingly unpredictable.

This may be why our investing environment has become so hard to understand.  Sophisticated capital intentionally following the trends established by irrational behavior. It should also be assumed that when powerful institutions such as this hedge fund change, they are not alone and where they lead large pools of money follow, further exacerbating the trend.   

It is most important to understand the realities in the marketplace and to adapt. Importantly, adapt does not necessarily mean change your strategies. We have been advocates of fundamental investing suited to your needs, resources and interests. Current market realities may require a change in expectations, timeframes and possibly risk tolerance to account for the new levels of volatility in the stock market. The key is to be aware of the environment, think through the change and adjust accordingly. You don’t have to follow a trend, especially one predicated on dubious grounds.

 ---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.