When all else fails, rely on intuition for tricky trading
• An innate reaction can help when confronted with complex problems
Agiant ship’s engine failed. The ship’s owners tried one expert after another, but none of them could figure out how to fix the engine. Then they brought in an old man who had been fixing ships since he was a young boy. He carried a large bag of tools with him, and immediately went to work.
He inspected the engine carefully, top to bottom. Two of the ship’s owners were there watching, hoping he would know what to do. After looking things over the old man reached into his bag and pulled out a small hammer. He gently tapped something. Instantly, the engine lurched into life. He carefully put his hammer away. The engine was fixed!
A week later the owners received a bill from the old man for $10,000. “What?” they exclaimed. “He hardly did anything!” So they wrote the old man a note saying, “Please send us an itemised bill.” The man sent a bill that read: “Tapping with a hammer: $2. Knowing where to tap: $9,998.”
Knowing where to tap makes all the difference, whether you are working on a ship’s engine or in the stock market. It’s about experience, intuition and having an edge. Economist Friedrich Hayek noted that “practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made”.
“The problem is that people are tripping over each other. Everybody’s got to rush in because they have to do what everyone else is doing,” said Justin Mami, author of several books on the stock market, “and everybody knows everything at once. It didn’t used to be that way. The machines are in everybody’s offices now.
“The minute the market goes down the put buyers are out buying puts within seconds. Within two minutes the guy on CNBC’s saying: ‘Is this the start of the long-awaited correction?’ And the next day, not only in The Wall Street Journal, but in USA Today, the headline is: ‘Has the correction started?’
“This short-term opinion/ information has added to the emotional nature of the market. Someone sitting at home at night putting in computerised data to look at this market is using old information. Everybody has become so short-term orientated that the movements are emotional, and I don’t see how you get emotions out of the computer.
“I’m convinced, having done this for several decades, that what you need is some degree of feel for the market. I’ve learnt over the years that those who have an intuitive reaction — based on experience and an innate ability to sense what’s going on — do the best in the marketplace,” Mami says.
“My decisions are really made using a combination of theory and instinct. If you like, you may call it intuition,” says George Soros. Nor is he the only great investor to rely on his intuition.
“It resembles a hidden supercomputer in the mind that you’re not even aware is there,” says Michael Steinhardt.
Unfortunately, professional intuitions do not all arise from true expertise. Daniel Kahneman attests to this in his book Thinking Fast and Slow, where he tells of a meeting with the chief investment officer of a large financial firm who tells him he
has just invested tens of millions in the stock of Ford Motor Company. “When I asked him how he had made that decision,” says Kahneman, “he replied that he had recently attended a motor show and had been impressed. ‘Boy do they know how to make a car!’ was his explanation.”
The chief investment officer made it very clear that he trusted his gut feelings and was satisfied with himself and his decision.
“I found it remarkable,” says Kahneman, “that he had apparently not considered the one question that an economist would call relevant: is Ford stock currently underpriced? Instead, he had listened to his intuition; he liked the cars, he liked the company, and he liked the idea of owning its stock.”
“When confronted with a difficult question and a skilled solution is not available,” explains Kahneman, “intuition still has a shot. An answer may come to mind quickly, but it is not an answer to the original question.”
The question the executive faced (should he invest in Ford stock?) was difficult, so the answer to an easier related question (does he like Ford?) came readily to mind and determined his choice. “This is the essence of intuitive heuristics: when faced with a difficult question, we often answer an easier one, without noticing the substitution.”
What sets the great investors apart is an intense learning process that involves not just an intellectual understanding of what to do, but a deep body sense of what to do. It is the acquired ability to approach complex situations in a highly efficient manner.
“They are the people who have studied years of charts or read hundreds of financial reports and developed a deep knowledge out of which their investment insights emerge.
In a parallel universe they would know just where to tap with a hammer to get a ship’s engine going again.