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)

Two Roads to Contrarian Practice

The old proverb The road to hell is paved with good intentions has roots in human psychology, in perfectionism (Powers 2005) [1] and ethical intent valuation (Kruger 2004) [2]. The Powers study indicates that perfectionism backfires:

The results of both studies revealed a significant backfire effect of the implementation intentions on goal progress for participants high on a particular dimension of perfectionism (socially prescribed perfectionism). These perfectionists reported doing significantly worse at reaching their personal goals when they were asked to formulate implementation intentions than when they completed a control exercise. There also was evidence that implementation planning aroused negative affect for socially prescribed perfectionists. These results are the first to suggest that implementation planning may be contra-indicated for individuals with self-critical tendencies.

Kruger and Gilovich have argued that

Actions and intentions do not always align. Individuals often have good intentions that they fail to fulfill. The studies presented here suggest that actors and observers differ in the weight they assign to intentions when deciding whether an individual possesses a desirable trait. Participants were more likely to give themselves credit for their intentions than they were to give others credit for theirs...

But these studies, which cover only part of the phenomenon, may fall short in other ways, as pointed out by (Gioia 2021)[3]:

The assumptions we have typically used to formulate our theories and conduct our research have led us to be seen as irrelevant by an audience we should want to engage. Consequently, our approach to research and writing has put us on a road to hell. 

In other words, the intentions of researchers may be good, but their results, well...

So let's step away from academics for a moment. After all, you and I could probably come up with better stories about why this is true: People plan to be better than they actually are, and they fail to make sure that what they are doing is actually a good thing in its outcome. That happens because generating the intended result is hard. Having an intention is 100 times easier than following through in full, measuring the result, checking, and having the outcome audited by a third party. If you are measured by your words rather than outcomes, which is usually the case for most elite public intellectuals, then outcomes don't matter much to your reputation, salary increase, or Twitter follower count.

The Road to Heaven

One can take Nietzsche's aphorism from Twilight of the Idols

Out of life's school of war: What does not destroy me makes me stronger.*

and use it to flip the traditional proverb on its head to get

The road to heaven is paved with the bad intentions of others.

This a near-perfect copy of one of my first tweets on Twitter, and remains pinned today because I still feel it is subtle and profound. What this says is

When circumstances, the universe, or other people put obstacles in your path, your ethical and thoughtful response to them not only sets you up for success, but gives you moral authority and superior character.

This seems to be easily misinterpreted. Typically, someone will come with a Nazi-based example or a health problem to disprove it. But notice that by contradicting the saying or attempting to thwart it with rhetoric, they are fulfilling the implied prophecy of success through prolonged conflict!

The point is simply one should expect obstacles in any project, and by overcoming them you build character and succeed. If you are declaring a scientific hypothesis, the worst thing that could happen is that no one challenges it, until you have to go public. Instead, you need as many challenges of the hypothesis as soon as possible. If the challenges succeed then you have the raw data you need to revise the hypothesis. Your hypothesis gets better by being challenged, not by being accepted.

Contrarianism of the Road

The power of such proverbs is that they contradict naive common sense with a much more nuanced and useful understanding. When a politician says that their policy will help you ("road to hell"), you should be highly suspicious and check for the unintended consequences that they almost certainly are overlooking, probably on purpose. Conversely, when you encounter lemons ("road to heaven"), look for ways to not only make lemonade, but also to grow lemon trees, found a beverage company, cure scurvy, and create a line of skin care products using lemon oil.

[This is the first article in a series on contrarianism.]

* There is a useful answer to a StackExchange question that is worth reading about this aphorism. Some contend that the aphorism is widely misunderstood. It may be the case that Nietzsche's purpose is not fulfilled by the popular understanding, but that doesn't mean that the popular understanding, in its more nuanced form, is not useful as well.

References

1.   Powers, T. A., Koestner, R., & Topciu, R. A. (2005). Implementation Intentions, Perfectionism, and Goal Progress: Perhaps the Road to Hell Is Paved With Good Intentions. Personality and Social Psychology Bulletin, 31(7), 902–912. https://doi.org/10.1177/0146167204272311

2. Kruger, J., & Gilovich, T. (2004). Actions, intentions, and self-assessment: the road to self-enhancement is paved with good intentions. Personality & social psychology bulletin, 30(3), 328–339. https://doi.org/10.1177/0146167203259932

3. Gioia, D. (2021). On the road to hell: Why academia is viewed as irrelevant to practicing managers. Academy of Management Discoveries, (ja). Published Online:19 Oct 2021. https://doi.org/10.5465/amd.2021.0200

P.S.: If you search online for "road to heaven" most of the hits will be more recent than October 2020. But there is one question that was asked on Quora in 2014 that uses this phrasing. If you look at the log of that question, it looks like no one answers the question about heaven, preferring to focus on the traditional "road to hell" proverb and its meaning.