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

The culprit always arrives within the hour

The brain works that way, and almost everywhere it is an advantage: I eat that berry, I feel ill, I don’t eat it again. Cause and effect, once, lesson learned. On a market, though, the participants are in the millions, they act for different reasons and partly watch each other: today’s result doesn’t come out of one cause, it comes out of the interaction between many.

Financial commentary has built a trade on top of this. Not because it is dishonest — it usually believes it — but because it answers a real need: if I know why it fell, I also know when it will rise. It is an illusion, and it is a consoling one. The point of this piece is that you can measure what it is worth.

The proof is in what happens next

The next day it rose 104 times and fell 80: a 57 percent chance of rising, which is what a coin with a heavy thumb on it says. At five days nothing changes: 105 times higher, 79 times lower.

The one thing that genuinely changes is the size of the move. The day after a heavy fall the market moves on average 3.6 percent against the 2.3 of an ordinary day: you don’t know where it goes, you know it goes harder. That is less satisfying than a culprit and far more useful, because it is the only one of the two things you can decide anything about — how much to risk, not which side to be on.

Why an incomplete explanation costs you

If you believe it fell because of the central bank, your strategy becomes waiting for the central bank to change its mind. If instead it fell through the interlocking of six things of which that is one, you are waiting for a signal that will never arrive — and in the meantime you are making decisions with a model of the world that doesn’t match the world.

The factory mechanism is always the same: take a complicated phenomenon, isolate one element that genuinely plays a part, and present it as the cause. It works because a single cause is easy to understand, to remember and to repeat. “It fell because of the Fed” travels; “it fell through a combination of liquidity, derivatives positioning, general mood, a few cascading liquidations and probably some chance” doesn’t travel. The first sentence spreads, the second is true.

What I watch instead of the culprit

The first: ask who is on the other side and what they gain. A fall where the large holders are selling and one where the small leveraged accounts are selling are two different things even when the chart is identical, and in the second what you are looking at is a line of positions closing themselves.

Put bluntly: if the market falls and you find the culprit in ten minutes, you haven’t understood the market — you have found a person to blame, which is a different thing and costs less effort.

The second: think in probabilities instead of certainties — which means accepting that the 57 against 43 above is all there is, and building a measure of risk on it rather than a forecast. And the third, which is more a matter of hygiene: be wary of whoever speaks with more confidence. In markets, as elsewhere, certainty of tone is almost always inversely proportional to how much somebody has understood.