#86: Disposition Effect vs Diamond Hands

Author

micksonmatch
June 24, 2024

Today’s post is going to be a little more wordy than it usually is; warning for new subscribers.

S2N Spotlight

Last night I watched a movie, Dumb Money, based on the true story of GameStop. The remarkable part is that the story as told in the movie is amazing on its own. However, we know that there is a part two being played out right now and is potentially even more amazing.

There are a couple of really interesting themes at play with GameStop part one. I still need to think some more about part two. Keith Gill a 34yr old down an out analyst decides to bet all his savings, $53,000 on a stock GameStop that he thinks it is undervalued. He manages through a Reddit group called Wall Street Bets and his Youtube and Twitter/X account to galvanize an army of young anti-establishment retail traders to take on and beat Wall Street. He turns his $53k into $50 million and a number of other loyal followers make F.U. money.

The part I want to focus on is one of the hardest things a trader or investor has to deal with. Its called the disposition effect and is pure psychology.

The disposition effect is a behavioural finance phenomenon where investors tend to sell assets that have gone up while holding onto losers. Every trading coach or investment guru will tell you to let your winners run and cut your losses early. The disposition effect can be attributed to psychological factors such as loss aversion and the desire to avoid regret. It was made famous by Terrance Odean, who in his 1998 paper “Are Investors Reluctant to Realize Their Losses?” He showed how the disposition effect leads to suboptimal trading strategies and can negatively impact overall investment performance. I would put money on him not being able to reproduce his results today.

I feel uniquely placed to comment on this behavioural bias. In one of my previous companies we analysed over 100,000 trading accounts and did extensive analysis on this subject. I got quite excited when I reached out to Professor Odean to perhaps collaborate on some research. He was very friendly but I cannot remember why the collaboration never happened. Anyway he probably wouldn’t have liked the fact that despite all the 100’s maybe 1000’s of papers on this subject we could not come to a conclusive conclusion that the disposition effect was bad for trading. Let me park my academic hat and not get caught in the weeds. I will just leave some of you with the comfort that if you have a strategy or investment approach that displays disposition effect don’t panic. You can still be great.

So how the hell did Keith Gill aka Roaring Kitty manage to hold out and convince his followers to go against the all powerful disposition effect? I believe in 2020 when this “game” came into play the trading zeitgeist was practising a new religion of “HODL”, “Diamond Hands”, “Buy the Dip”, lead by high priests Michael Saylor, Keith Gill, Dave Portnoy and others.

In the movie you feel just a tiny bit of the psychological angst they go through. As an ardent student of Jungian psychology I can tell how these people were/are experiencing a cultural complex under the sway of a saviour archetype. I am going to stop my analysis here as it will be better for me to write in more detail as a blog post, where I am not so self-conscious of the number of words I am writing.

The part that blows my mind is that I know how the story ends in 2021. Right now Keith Gill upped the stakes and was making $250 million on the 6th of June and losing $200 million on the 7th. A judge in a famous case in Australia a few months said of the defendant in his judgement, “having escaped the lion’s den, Mr Lehrmann made the mistake of coming back for his hat”.

S2N Observations

I have been saying for some time that I believe the yen is going to continue weakening past its previous low of 160 (the yen is presented the opposite way to most dollar pairs). The BOJ has said they will continue to defend whenever needed. They spent (blew) over $60 billion defending it in May, which didn’t help much. The note on the chart is from what I shared a week ago, I feel the same way today.

I have also been pretty vocal that I am bearish the US markets with the Nasdaq in particular. It seems like this may be a pivotal time. It has been 379 days since the last -3% down day. I think its coming pretty soon.

As someone who is not afraid to have a different point of view to the crowd. I wanted to share something that I am pretty sure not too many analysts have seen before. GFD produce the most incredible long term dataset I have ever come across. I tried to subscribe to their data but would need to sell a kidney to afford it. Thanks to Meb Faber you can see in the chart below 3 different series over more than 200 years of data. They show the percentage concentration of the top companies compared to the total market of companies.

Every market commentator is discussing the magnificent 7, me included, speaking about the concentration in the top companies being unhealthy. If you look where we sit today we are not near any major extreme in comparison to the past 200 years. Just some food for thought.

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