Economic Valuations That Don’t Make Sense

Hello traders! This week’s newsletter will discuss the problem that comes along with knowing TOO MUCH about economics and fundamental valuations…

In my fourteen years of teaching for Online Trading Academy, and my 28 years of market experience, and my economics degree, I’ve often looked at price charts and thought to myself, “This thing shouldn’t be way up (or way down) here! The valuation, the interest rate differential, the economic this or the economic that should price this thing far from where it is! What do I know that everyone else doesn’t?” Then I would proceed to try to figure out why things were, what I thought was, mispriced. And I’m not the only one. In fact, I’ve had many students over the past years question the same thing, whether it was the price of gold futures, stock index futures, crude oil, the Japanese yen, etc. etc.

In my Forex course a couple of weeks ago, I had a student who came to us to better understand how markets really work. This student and I talked frequently during the week about where prices on assets should be according to traditional economics. The conclusion? IT DOESN’T MATTER. It just is. It doesn’t matter because we believe that the institutions move the markets with their massive buy and sell orders, if they want to be buyers, we should be buyers. If they want to be sellers, we should be sellers. End of lesson.

Ok, perhaps not quite the end. Here are a couple reasons why we need to accept the reality just mentioned:

1. We may NEVER know WHY the institutions are buying or selling. They may have a huge algorithm with a thousand inputs saying buy here or sell here. They may have inside information that we won’t see for days or weeks (or ever!) as to why they are buying or selling. If we spend minutes or hours trying to figure out the why we will probably miss a trade or ten, wasting all this time trying to justify a move we don’t understand.

2. If you believe (for whatever reason) that the GBP/USD currency pair should be trading closer to 2.11, (it’s high for the past twenty years) instead of where it is (about 1.30 at the time of this writing) you would have lost money for YEARS trying to keep going long while the pair is in a downtrend. A trader’s stubbornness that they know where it should be will prevent many winning trades from happening, and probably keep them in many losing trades! Just ask some hedge fund managers who were short Netflix (NFLX) or Tesla (TSLA) over the past few years.

The absolute bottom line is this: the institution’s reasons may never be known, and the reasons may even be illogical! Trying to justify the why can waste a lot of time contemplating the reasoning and cause a lot of frustration when valuations don’t match up with price. So, calm down, put your trust in buying in demand zones in uptrends and selling in supply in downtrends, and let the institutions do all the research and work determining what to buy and what to sell.

Last word on the subject: one of my first trading mentors way back in the 1990s said to me: “Do you want to be right or do you want to be a consistent trader? Traders trying to justify positions going the wrong way end up not taking small losses and have trouble maintaining consistency in the markets. Eventually, they might be right once in a while, but that will likely not be fulfilling if they have been suffering large losses. Traders who quickly take small losses and let winners run have an edge.”