Contrarian Trading Physics

In the previous article, I may have left some with the impression that the "road to heaven" maxim as a contrarian principle was a mental trick, mere psychology. I apologize for the unfortunate emphasis. Contrarianism is built into physics. You can start with Newton's third law of motion:

To every action there is always opposed an equal reaction; or, the mutual actions of two bodies upon each other are always equal, and directed to contrary parts.

At the very least this implies that to make a change that you want to occur you must experience a force opposite to that you intend to apply. 

We can move forward to the trite and obvious, but frequently disobeyed maxims of trading securities:

Buy low, sell high.

You pay a high price for a cheery consensus.

Make a stand, lose a grand. Have a hunch, make a bunch.

To use the first law you usually have to buy when everyone is fearful, and sell when you feel like everything is going your way. The second is similar; if everyone agrees that you are buying the right investment, then it is probably too expensive. This is not just mind games. This is physics of group thought.

The third gets a little deeper into the psychology (self-contrarianism) of trading: When you try to make something happen, it often goes awry. When you are just inferring, often from scanty evidence, that something might happen, you are often right. 

This leads to some principles of trading that I sometimes use:

1. When you've done some research and found a good investment, buy a little at the start. If you buy too much, it will decline. Buying only a little either insures that it does go up, or that you will get a second chance to buy more at a lower price and to re-evaluate your logic.
2. If you have an informed hunch, buy fast and at the market. It's no use trying to capture a 5 cent spread with a limit order and missing a $2 gain over a week's time. If you find yourself hesitating, stop and don't do it.
3. When the market makes you nervous, but you like your stocks, switch it off, stop checking, and do something else entirely. This especially applies when I have what I call "market maker-stoppers", stocks that I will probably hold effectively forever anyway. I gain and they lose the bid-ask spread on the dozens of trades I never make.

Between 2020 and 2022 principle #3 probably made me more money than any other action. The market is full of noise. Once you have a position, just stick with it. 

This brings me to the most contrarian point of this blog: Though it is titled Vorpal Trade, very little of my commentary will really be aimed at short-term trading. Vorpal Investment just doesn't have the same ring. Which would people be more likely to remember? Which one captures your attention?

Now that I've slipped into the psychological aspects of trading again, it's time to cite biological examples. 

Muscles grow stronger when they are used. They grow weaker if they are not. Species undergo faster evolution in heterogeneous environments. A species which enjoys a uniformly benign environment is therefore less robust against changes to its environment. In any heterogeneous environment, the best ways for an animal to make a living are to move into ecological niches that no other animal is exploiting. In any species, members of the species are in conflict with those that prey on them, but possibly even more in conflict with other members of their own species when it comes to reproduction. Among plants, the tallest one gets the sunlight, but those plants which can specialize as vines and parasitize the tall plans by growing as vines will get the sunlight without investing in costly woody parts.

The structure of the financial system contains many, many contrarian elements. Government guarantees lead to systemic weaknesses. Mandates to service particular markets induce over-consumption leading to societal dead-weight losses and add systemic risk. Taxes reduce market sizes, distort markets, reduce and overall economic vitality. Subsidies lead to overuse, excessive prices and speculation, and destabilize markets. Good-meaning policies lead to more policies which lead to (undetected or "I don't want to see that") bad policies which undermine the financial system. 

I'll leave these statements here without proof, because this is not intended to be a political article. If you want to see some of the logic, here are a couple of places to start:

Lindsey, B., & Teles, S. M. (2017). The captured economy: How the powerful enrich themselves, slow down growth, and increase inequality. Oxford University Press.

Sowell, T. (2011). The housing boom and bust. Basic Books.

(this is part two of a series on contrarianism)