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Quite proud of that clickbait title if I'm honest.

Don't worry, we're not getting into gender studies and we're not encouraging anyone to become a trader/investor/degenerate like us.

But if you're going to do it regardless...

Be non-binary...

Let's use this example to explain what I mean.

'John' asks:

"If the Fed taper, will it be bad for stocks?"

It's a nice simple, binary question, right?

John's looking for a Yes/No answer... Presumably to decide if he should be long or short stocks.

Although market outcomes are sort of binary (number go up/number go down), the drivers of those price movements rarely are.

As it is in this case.

Imagine John decides that Yes! the Fed tapering will be bad for stocks.


"Wait, the Fed announced the taper and stocks went UP?"

John got screwed by the simplicity of a binary approach: If this then that.

It's understandable. We all start here. Our brains are hard-wired to generalise, categorise and seek 'certainty'.

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Now, let's try the non-binary approach.

But we'll call it something different: The probabilistic approach.

See, markets don't exist in a vacuum. Millions of people around the world participate every day and they're all adding their 'opinions' into the mix when they buy or sell...

Those opinions aren't about what has already happened.

They're opinions of the future based on what is already known...

Rumsfeld Matrix

Let's keep this in mind and go back to the tapering good/bad for stocks question.

Fed communication on tapering has been so drawn-out and so clear that I'm sure the announcement falls into the known knowns section.

So, the first thing to notice here is that the taper is already in the current pricing.

It might not 'officially' be known but the market is acting as if it is and that's all that really matters.

Put another way, the announcement of the taper is not going to make large numbers of traders change their opinion. It will shock no-one.

Which means we can reduce this back down to a binary question...

"If the Fed taper, will it be bad for stocks?"


Excellent, let's get long then!

S&P closes 1% lower after the announcement

DUDE WTF? We agreed taper wouldn't be bad for stocks. Why did I lose money? πŸ‘‡

Alright, fine, were there other factors that I completely ignored?

Just because the taper wasn't going to be negative for stocks, doesn't mean it's positive. It just means it can be disregarded as a non-factor.

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What else is there?

  • Market performance heading into the event
  • Prior market performance heading into similar events
  • Probability and timing of future rate hikes
  • Taper was announced at a different pace than expected
  • and so on...

Don't forget to throw in Keynesian Beauty Contest dynamics for good measure πŸ‘‡

Then there's the filtering of all of these factors to figure out the most likely scenario and the most likely outcomes...

Over time, it's basically this πŸ‘‡

The balance between complexity and simplicity...

It's not something that can be learnt from a book either.

This is not a 'natural' way of thinking for the HumanOS so it needs to be practised, reinforced and takes time. Those new neural pathways won't form overnight...

Which is why it's usually a painful journey towards 'enlightenment' πŸ‘‡

Here's a couple of primers on probabilistic thinking and heuristics πŸ‘‡

The Value of Probabilistic Thinking: Spies, Crime, and Lightning Strikes - Farnam Street
Probabilistic thinking is a useful tool to help us evaluate potential outcomes so we can make the best possible decision. Learn why it matters, and how to use this powerful mental model.
Heuristics - The Decision Lab
Heuristics are mental shortcuts that can facilitate problem-solving and probability judgments.

Don't know what financial news stories are important and what is complete bullsh*t? Hop onto our filtered news channel.

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And if you really want to get to grips with how global markets and economics work, with trade ideas to give you actionable context, then come and join us as a premium member where you're likely going to get a nice Market IQ boost. πŸ‘‡

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