Hunting for the culprit makes you feel in control and understand less

Why does the culprit always turn up within the hour?

That’s how the brain works, and almost everywhere it’s an advantage: I eat that berry, I feel sick, I never eat it again. Cause and effect, once, lesson learned. In a market, though, there are millions of participants acting for different reasons and partly watching each other. Today’s result comes out of a tangle of causes, never out of a single one.

Financial commentary has built a whole trade on this. It often believes what it says, so this isn’t about dishonesty. It answers a real need: if I know why it fell, I also know when it will rise. It’s an illusion, a comforting one, and the point of this piece is that you can measure what it’s worth.

The proof is in what happens next

The next day it rose 104 times and fell 80. That’s a 57 percent chance of rising, roughly what you’d get from a coin flipped with a slightly heavy thumb. Five days out nothing changes: 105 times higher, 79 lower.

The one thing that really changes is the size of the move. The day after a heavy fall the market moves 3.6 percent on average, against 2.3 on an ordinary day. You don’t know where it’s going, but you know it will move harder. That’s less satisfying than a culprit and far more useful, because it’s the only one of the two you can act on. It tells you how much to risk. Which side to be on is anyone’s guess.

Why does an incomplete explanation cost you?

If you believe it fell because of the central bank, your strategy becomes waiting for the central bank to change its mind. If it actually fell because of a tangle of six things, and the central bank is only one of them, you’re waiting for a signal that will never come. Meanwhile you’re making decisions with a model of the world that doesn’t match the world.

The way these explanations get made is always the same: take a complicated phenomenon, isolate one element that really plays a part, and present it as the cause. It works because a single cause is easy to understand, remember and repeat. “It fell because of the Fed” travels. “It fell through a mix of liquidity, derivatives positioning, general mood, a few cascading liquidations and probably some luck” doesn’t. The first sentence spreads, and the second is the true one.

What do I watch instead of the culprit?

The first is to ask who is on the other side and what they gain. A fall where the big holders are selling and one where small leveraged accounts are selling are two different things, even when the chart is identical. In the second, what you’re watching is a line of positions being forced shut.

Put bluntly: if the market falls and you find the culprit in ten minutes, you’ve found a person to blame, which takes far less effort than understanding the market.

The second is to think in probabilities instead of certainties. That means accepting that the 57 against 43 above is all there is, and building a measure of risk on it rather than a forecast. The third is more a matter of hygiene: be wary of whoever sounds most sure. In markets, as elsewhere, the more certain someone’s tone, the less they have usually understood.