I’ve been thinking about the relationship between human behavior and money for my entire career at TradeSmith.
We all know these things are intimately tied together. But it’s not immediately clear why.
Money seems like should be this cold, calculating kind of field where emotions play no role. Yet, they always do.
I think I know why:
For the vast majority of time that humans have been on the planet, there has been no form of money or investment. We earned our keep by hunting, gathering, and bartering with others.
We’ve really only been thinking about money for a couple thousand years… and for most of that time, it was only a concern for a tiny sliver of the population – kings, dukes, and other members of the top 0.01% of society.
As society progressed into the modern age, more and more people have had to think about and use money in a complex way.
Through this lens, we can see what money really represents and why it has such an emotional pull on us.
It’s our livelihood.
In the same way that our ability to bring down a wildebeest with a sharp stick meant our livelihood for tens of thousands of years, we’ve swapped that with our ability to build wealth by acquiring units of paper.
We don’t hunt for food anymore, we grocery shop… with money. We don’t stake our claim on a piece of land by threat of violence… we buy a home or rent from a property owner… with money. We pay for access to clean water and heating and cooling… with money.
And not only do we spend our money to live, we risk it to get ahead by buying assets that we hope will go up – multiplying the complexity manyfold.
Money and investment is a relatively recent idea in human history. And it’s been a big adjustment for the human psyche in a short period of time. This should explain why people have such visceral, emotional reactions to both making or losing it.
These reactions, especially in the investment world, are almost always harmful.
That’s why everything we do at TradeSmith is to save you from acting on your emotions, and rely on the cold, calculating data that produces far better outcomes.
Now, I’d like to say I came up with all this myself. But the truth is, I owe a lot to two men who were among the first to recognize the emotional connection to money: Daniel Kahneman and Richard Thaler.
The Giants’ Shoulders We Stand On
In 1675, Isaac Newton wrote, “if I have seen further [than others], it is by standing on the shoulders of giants.”
We won’t claim we’ve “seen further” than Kahneman and Thaler. But we have applied their philosophies in a unique way that keeps you from irrational decisions.
One of their biggest contributions to behavior science was the idea of “loss aversion.” That’s where we feel a great deal more emotional pain from losing money on our investments than joy when they gain.
A total loss, even one from $1 to $0, feels far more painful than doubling your money from $1 to $2.
Loss aversion is what drives investors toward “panic selling.” They hate the idea of losing so much, they immediately (and irrationally) accept large losses out of fear that those losses will get even larger.
Market history shows us that crashes are temporary, so panic selling is almost never a good idea. In time, every market crash has proved to be a buying opportunity… and any desperate action to sell assets at a loss tends to foster regret later on.
That’s why we built TradeStops. It’s a simple software solution that gives you a clear level to sell any asset you own, down to the cent. With it, you don’t sweat market selloffs. You know exactly when to act – and that’s when an asset you own crosses into our Red Zone.
Let’s look at a couple examples…
Below is a chart of the S&P 500 index going back to 2019, with our TradeStops signals marked in yellow and red.
The yellow line is a “warning” level. When the S&P crosses into that line, it means it’s at about the halfway point between its high and the level we consider the right place to sell:
The right place to sell is the Red Zone, or the red line above. We determine that by looking at each asset’s long-term volatility patterns, calculated as our Volatility Quotient.
What this simple chart shows you is the advantage TradeStops gives you as a human, emotional investor. Look at all those bad days where the market swiftly traded down, erasing billions in value. We can look at October of 20-23, April of this year, and even this past summer as times where stocks retreated from their highs, but never got anywhere close to our suggested selling point.
Many investors reacted to these corrections with fear… and might have sold their stocks thinking that they got out before a big crash. But our research shows that major crashes just aren’t likely until prices hit our Red Zone. And right now, that Red Zone is all the way down at 5,000 on the S&P 500.
Let’s look at another big asset we track: gold.
Gold – specifically, the SPDR Gold Shares ETF (GLD) is what we’re looking at in this chart – has been on a tear in 2024:
GLD started the year at about $195 per share and last traded hands at more than $250. That’s a roughly 30% gain, and it’s also outperforming stocks this year.
Our recommended sell price for GLD is down at $220. But I want you to pay attention to the green bubble at the bottom left of the chart.
That’s our entry signal. It flashes when an asset has risen enough from the Red Zone, which for GLD was back in December 2023.
Had you followed that signal, you’d have enjoyed the entirety of 2024’s gold gains… and be in a great position to hold on through a short-term downturn.
In the case of the S&P 500, you can see that our last entry signal was all the way back in June 2023. Since then, stocks are up more than 30%.
So, not only does our algorithm help you from avoiding needless losses… it helps you get into assets at the right time. That way, you can ride them higher and be that much further from a loss in the first place.
What we discussed today is just one of many lessons we’ve learned from behavioral psychology – both from studying Kahneman and Thaler, and from our own research.
With the election coming up, we’re about to enter a potentially volatile stretch in the markets. If things get ugly, I want you to remember what you read today.
The only good time to sell stocks is when the data supports it – not our emotions.
We’ve cracked the code on when that time is. And so long as you stay tuned with us, whether you subscribe to everything we create or nothing at all, you have our promise that we’ll tell you when we get a true sell signal on the markets that’s worth paying attention to.
In the meantime, I always love to hear from you at feedback@TradeSmithDaily.com with any thoughts or questions you might have. I’ll look to publish my responses in a future issue, if we think they’ll be helpful for your fellow readers.
All the best,
Keith Kaplan CEO, TradeSmith
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