Calling the bottom
The phrase „calling the bottom“ is another way of saying that a bottom is in (according to the one calling it) and that higher prices will be seen going forward. For instance, calling the bottom in gold, means saying that the bottom in gold is in.
This phrase (or other similar ones) is often used by journalists and beginning investors because it appears straightforward, makes investing or trading similar to other areas of life (one is either right or wrong, wins or loses, just like in many sports), and it makes it easy to judge one’s performance – whether that’s a good estimate is a different matter, but it seems easy.
In our opinion, the above phrase is harmful and it should not be used. The reason is that it – in a subtle and discreet way – justifies or emphasizes the incorrect approach toward investing – a way that can and likely will make one lose money sooner or later.
There are 3 major problems with „calling the bottom“:
- It emphasizes the significance of short-term performance whereas the emphasis should be on the long-term performance. Journalists want an exciting story that will get the people’s attention – bold statements like „XYZ calls the bottom!“ or „XYZ misses the bottom!“ are exciting, relatively simple to understand and don’t require the journalist to posess specific knowledge about the investing business (in fact, most journalists know very little about investing and trading but that doesn’t deter them from writing about it).
Your portfolio doesn’t care about what’s exciting – it cares about what’s profitable. Precisely, the „portfolio cares“ about your overall approach and whether it results in systematically greater values of the portfolio or not (and not about a single trade, or whether a single trade is opened or closed very close to a price extreme – a bottom in this case).
If one „calls the bottom“ correctly one time and then doesn’t trade for months (and there are tradable bottoms and tops during these months), it will get journalists excited, but this person’s portfolio will likely not be as profitable as the portfolio of someone who didn’t call the bottom, but was close to it 4 times and conducted several smaller (not exciting) but profitable trades.
- It distorts the true performance of the analyst that is „calling the bottom“. In a way, it’s what we wrote about in the first point, but in this case it’s not about one’s portfolio but about judging the analyst‘s abilities based on the results of only one call.
The key thing to keep in mind is that investing is not a single-round game. It’s a process and the success depends on the cumulative results of multiple „rounds“ (hundreds of decisions – not just one). We know that beginning investors quite often see analysts as only as good as their last call. Consequently, those investors will simply switch from following one analyst to another one every several days or weeks (eventually everyone has to make an incorrect prediction as it’s not possible to be correct at all times – at least not when making precise predictions). Since one would switch analysts and the analysis that they are following more or less randomly (the above is – in fact – random as being incorrect has to take place from time to time eventually in case of all analysts), they would on average get the average of the analyses and signals from all analysts (at least those that they chose to take into account). In other words, instead of moving to a better analyst and better analyses and signals, investors would simply get the average performance.
Average perfomance implies no difference between this approach and simply choosing an analyst randomly – which means that this approach doesn’t result in any positive outcome for this investor – they are wasting their time trying to choose the best analyst because they are not using the correct process to identify them. Again, investing is a long-term process, so it can’t be judged based on the „last call“ or by the fact that someone was able to „call the bottom“ at a certain time. For example, if there are 2 analysts: one was able to „call the bottom“ with great precision one time and failed to catch the 5 next moves at all (thus resulting in an overall gain of 20% on the invested capital) and the second analyst didn’t „call the bottom“ at all, but entered 4 trades and gained the total of 40%, then the second one is likely much more useful – even despite the lack of an exciting entry right at the bottom.
„Calling the bottom“ is a phrase that overemphasizes and „justifies“ as normal the former approach and focuses on the „exciting entry points“ instead of focusing on real performance. Consequently, using this approach could lower the value of one’s portfolio over time or decrease its rate of return.
- The „calling the bottom“ phrase emphasizes the „to be or not to be“ approach – that you have to „know“ for certain that a certain outcome is going to happen and then either stick to it (being consistent) or change your mind (admitting that you „failed“ to get the right conclusion the first time).
The problem with this approach is that people generally don’t want to admit that they failed at something and they will do a lot to avoid it. In this case, it can lead to „conservatism bias“, which means that one tends to ignore new information (regardless of how important it is) in order to stick to the original position. Naturally, markets don’t care about each individual investor’s initial thoughts and if they situation changes, they will change as well. It’s up to the investor or analyst to determine whether the situation has really changed in light of the new information but ignoring it each time is not a good and profitable approach. It can also lead to overconfidence („I know that the market will do this or that – I’m sure!“) and, in consequence, to excessive positions sizes .
Regardless of a single outcome, this approach will ultimately lead to disappointment every now and then simply because it’s impossible to be correct each and every time. Instead of trying to do the impossible, one can simply accept that it’s not possible to know for certain what the market will do and instead of saying that either this or that will certainly happen, they can simply present their thoughts (to others or to themselves) in terms of probabilities. If one conducts a through analysis and thinks that the market is likely (with 70% probability) to move higher and the market then doesn’t move higher – is this person wrong? No – the market didn’t move in the likely direction, but whether that person was right or wrong depends on the analysis and whether it was done thoroughly and with proper care.
If it sounds weird, please consider a similar situation: you toss a coin and you know it’s not fair – there’s a 70% chance that you will get tails when you toss it. Assuming you can bet money on it, you would likely bet on „tails.“ As there’s still a 30% chance of the outcome „heads“, it will be seen from time to time. When it does and you bet on „tails“ – were you wrong? No – you were correct; it simply didn’t work this time, but the approach was and still is good. It’s easy to judge others or oneself in most aspects of life as certain action results in a certain outcome – there is no room for randomness. However, it all changes when we have to factor in some uncertainty.
The only way that you can judge one’s performance (including your own) is by thorughness, care and dilligence with which the analysis was conducted and – more importantly – by the performance itself – however, not the short-term one, but the long-term one (how a certain approach, strategy or analyst has performed for more than a year).
Consequently, in our analyses and alerts, we don’t call tops in gold and we don’t call bottoms in gold. We are estimating the odds for given moves and once these odds – along with the projected size of the move – justify entering or closing a given position, we make a decision to open or close a position, but we remain humble regarding our abilities and at the same time we remain open to changing our minds in light of new circumstances – focusing on higher long-term performance, instead of making the headlines – is it through higher profits, not higher excitement that we aim to serve you.
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