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Your Gut Is Not Smart

Written by Briton Ryle
Posted January 14, 2019

Over the last few years, I've seen an alarming increase in the number of people who readily admit that they make all kinds of really important decisions based on gut feelings. 

Forget that brain. Never mind that it has an amazing amount of processing power and can take in a huge amount of really diverse information and make sense of it. No, we're going with our gut.

Gut feeling is exactly that: a feeling. Now, we humans are, at our core, emotional beings. And I love that fact. Emotion is what gets us love. Humor. Music. Roller coasters, cheeseburgers, and vodka. Without emotion, we'd be a bunch of rational Spocks. No fun at all. 

It feels good to go with your gut feeling. You know why? Confirmation bias. We humans like to see the things we believe proved correct in the world around us. And so it feels good to make decisions based on our own feelings rather than on outside information that may actually conflict with what we believe. Because when those gut decisions work out, we feel very much in tune with the world around us. We can relax. We got this. 

But don't forget, gut feeling is what landed Galileo in jail to die. Gut feeling is why otherwise normal grownups still say the Earth is flat and there were no dinosaurs...

Guts vs. Experience

I will even make a fairly significant confession here: gut feeling is part of my trading strategy. Investing, no. If I'm buying a stock or recommending one in The Wealth Advisory, Jason and I run the numbers, read the quarterly reports, evaluate the competition, assess the risks, and so on — and then make a decision. Plenty of companies don't make the cut.

For example, we've added a couple biotech stocks over the last couple years. I keep getting drawn to Gilead Sciences. Lots of cash, low P/E — but Gilead doesn't have a really solid growth catalyst. So it sits on the watch list where it's been for two years at least, vacillating between $65 and $80.

Sure, we could've made some money with a near-perfect entry. But investing isn't about perfect entries. Investing is about a management team and products/services that will grow your money over time. For a stock you're going to own for the next few years, missing a percent or two on the entry is literally the last thing you should be worried about. 

To me, options trading is a much more artistic pursuit than investing. Because I have yet to see a strategy that can perfectly tell you what one stock will do over the next two to seven days (my preferred timeframe). I start with a small stable of stocks (five or six) that I've done the full due diligence on, and then I trade the swings. There are a lot of helpful tools (support/resistance, Fibonacci levels, moving averages, etc.), but I still have to say the time is NOW, and click the buy button.

It's worked so far — I took over Options Trading Coach in mid-2017 and got 25 trades at an average gain of 14.6%. 2018 was 50 trades at 17.5%. So far this year, it's one trade, 172%, so yeah, done for the year. (Kidding!)

Now, I've been investing and trading for 20 years. I've seen economic cycles come and go. I've seen a huge number of momentum sectors run: internet stocks, oil stocks, gold, rare earths, solar stocks, cloud, cryptocurrencies, Chinese stocks, pot stocks, and on and on...

Different eras, sectors, and companies, yes. If you looked at the charts for each stock, there'd be hundreds. But if you couldn't see the names, you wouldn't be able to tell the oil companies from the solar companies or the Chinese stocks. Because investor behavior doesn't change all that much.

This is something that gets internalized with experience. You see things over and over again, and you get a feel for how investors will react to a pretty wide variety of scenarios.

A Little Indigestion

Right now, we have a president who loves to go with his gut feeling. There has been only one other time in modern history where the U.S. thought tariffs would help American workers: 1930. And it was a complete disaster. Yet here we are, in a trade war with China that is really starting to hurt the economy and cost people their jobs.

Trump also thought going outside the Fed for a new Fed chair was a good idea. His choice, Jerome Powell, pushed rates higher to the point that the market was begging him to stop.

Again, bad move. Interest rates, trade with the second biggest economy in the world (and the one many U.S. companies depend on for revenue/profit growth) — these are just not things you should listen to your gut on.

Of course, as individual investors, there's not a whole lot we can do about these dingbat politicians. The best course for us is to remain vigilant about honing our processes and making solid, rational decisions. Here are a couple thoughts...

*** Stocks have made a very strong recovery since the Christmas lows. But what's actually changed? The outlook from the Fed has changed. That's it. We've heard optimistic talk about the trade war, but no specific progress has been made. Yes, the markets were desperate for some good news, and investors have been buying the positive trade talks rumor. Will they continue to?

*** Fourth quarter earnings start... TODAY!! Citi (NYSE: C) beat on earnings, missed on revenue. The loss was largely due to fixed income trading, which is very dependent on interest rates. Yes, the Fed may be standing pat. But rates may still be a bit of drag. We simply don't know at this time. And given the stakes, don't ask your gut. 

*** Overall, we've seen stocks go from extremely oversold at Christmastime to pretty darn overbought now, less than a month later. That's a pretty good run. And we've seen analysts fall over themselves upgrading stocks and saying the market will head higher from here. Have you seen Netflix? Nearly 50% higher in the last three weeks. Sheesh. I get a little suspicious when everybody on Wall Street falls in line and says, "That's it, correction over." Don't forget the single most important phrase in investing: buy low, sell high. If the big money thinks prices are high, they will be selling.

*** Pro Tip: Big Money is not going to tell you they are selling. In fact, due to the simple fact that everybody can't get through the exit door at once, they'd rather you keep your seat while they go get popcorn or hit the bathroom or whatever. Don't worry, they'll be right back. At times like these, watch the Volatility Index (VIX). A big spike means the pros are selling.

*** I'm going to also say there are a few stocks you should keep an eye on. Nvidia (NASDAQ: NVDA) is one. This stock has been the poster child of the cloud/AI economy. And it's been absolutely crushed since October. Cut in half. If it puts in a strong rally, you know big money sees opportunity. If it doesn't, well, they don't. Starbucks (NASDAQ: SBUX) has been relatively unscathed during this correction. Surprising, because it is very dependent on China for growth. Watch the stock as an indicator of trade talk sentiment. Finally, there's Bank of America (NYSE: BAC). BAC is a pretty good proxy for the U.S. economy. It reports on Wednesday. 

That's what I got today. Take care, and I'll talk to you on Wednesday.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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