Reflexivity is your friend, a TigerInvestor.com article by Ram Shadari
We all know that the "Trend is your friend". However, I am sure many of you have not heard of the term "Reflexivity" or the saying above that I just created: "Reflexivity is your friend". After reading today's DMV, I hope some of you will feel that there is some truth to the above statement and that you can make some money off of this idea.
First, last night I mentioned that the market is irrational currently and that many market players believe that momentum is a new method of valuation. I brought up the example of Agilent (A) to make my point. I said that Agilent would run this morning because momentum players would be chasing this stock. Well, not quite. After P&G's shellacking of the Dow, there was not much "oomph" left in the markets. The Dow fell a nasty 374 points while the Nasdaq managed a small slide (down 57). So at least for now, I can't tell if the market is rational or not (with this stock - Agilent down 17 today).
Second, the big news of the day was Verisign (VRSN) buying Network Solutions (NSOL) for $21b though by the end of the day the deal value had shed a few billion dollars. None of this helped boost the Nasdaq though it was up nearly 70 points at the open. We also touched a milestone in that the Nasdaq Composite briefly went above 5000 before settling down for the day. This proved to me that yesterday was a reversal day at least for the near term. The biotechs also took a beating which means that profit taking is well underway. I would wait for the dust to settle before putting in some bids.
Now to my regularly scheduled talk. Reflexivity is a favorite term of George Soros and he uses it to explain a lot of things in the markets. Reflexivity means that an event is altered by the participants expectations about the event. That is to say, a party that is considered "cool" by its participants will in fact become "cool" as time goes on. This is a self reinforcing process as you can see.
To explain reflexivity in markets, I will illustrate simply by showing an example that everyone probably has encountered at some point in their investing career: have you noticed how the hype about a strong IPO creates a positive momentum in the stock that you can almost be certain that when they report their first earnings report it will be a blowout. You wonder: did some investors know in advance that the earnings to be announced will be a blowout and hence bid up the stock? Or did the positive buzz around the company help its marketing with potential customers that enabled the company to sell more and thus beat expectations? If you believe in "insider trading", you will believe in the former. If you believe in reflexivity, you will believe in the latter.
Remember this? When eBay (EBAY) came out virtually unknown 2 years ago, I didn't pay much attention to the stock. But after it started its incredible run day after day, I was tempted to believe that it was the biggest name in auctions even though until then it was still a small site. Only a month or two later, eBay posted a profit that blew away analysts' expectations and the rest they say is history.
So how can reflexivity help you? I normally use the good stock movement of a company to determine its "earnings surprise" potential and buy the stock ahead of earnings. This has helped me make money more times than not. Similarly, a poor stock leads to disappointing earnings in cases such as Cyberian Outpost (COOL) or Cybershop (CYSH). I am not saying that this always true (if so I wouldn't be writing this column). But if you understand the theory of reflexivity a little more, you are more like to be a better investor/trader.
Note about today: I mentioned yesterday that it looked like a reversal day and it seems to be the right call judging by the action in the Nasdaq today. I will hesitate to buy more until a trend is established.
(Disclosure: As of this writing, I hold none of the stocks/options mentioned in this column though positions can change anytime). |
